MLD (Market Linked Debenture)

What are Market Linked Debentures?

MLDs or Market Linked Debentures are fixed income securities with performance linked to a predefined market index. The linked market index could be an equity index like NIFTY 50 or a debt instrument like 10-year Government of India bond yield or any other index/price.

Typically, MLDs don’t have interest payments associated with them. They are zero coupon bonds.

What is the full form of MLDs?

MLDs stands for Market Linked Debentures.

Who can issue MLDs in India?

MLDs can be issued by companies with net worth of at least Rs. 100 crore. It is important to note that governments (state and central) do not issue MLDs.

How are MLDs linked to the market?

The payoff (returns) of an MLD is linked to the performance of an index.

For example, an MLD could have a clause like investors get 8% return if NIFTY 50 is at or above 13,000 during the time of maturity. If NIFTY 50 is below 13,000, the investor will lose all the interest (in case of principal protected MLDs) or lose all the interest + principal (in case of non-principal protected MLDs)

Are MLDs linked only to the equity market?

MLDs can be linked to any index across any asset class. It could be NIFTY 50 from the equity asset class or T-bill index from the debt asset class. The issuer of the bond chooses the index to link the performance of MLD to.

What are the types of MLDs?

MLDs are of two types: principal protected and non-principal protected.

Principal protected MLDs: These MLDs will protect the investor’s investment (principal) even if the external index hasn’t moved favourably for the investor. The maximum loss for the investor is only the interest.

Non-principal protected MLDs: Investing in these MLDs is very risky because the investor may lose all his investment as well as the interest.

Are MLDs risk free?

MLDs are not risk free. In fact, the performance of the market is an added risk in MLDs when compared to other bonds.

Who should invest in MLDs?

Investors should consider MLDs only if they understand bond risks and the additional risks of market linked performance being a factor. Retail investors with limited knowledge of bonds should stay away from MLDs or seek financial advice before investing.

Market linked debentures taxation

MLDs have a different treatment from normal bonds because the payoff is market-linked.

Taxation on interest payments of MLDs: Taxed as per marginal income tax rate of the investor

Taxation on capital gains of MLDs: Listed and unlisted MLDs have different capital gains tax treatment. Listed MLDs are taxed as per investor’s marginal income tax rate if held for less than 12 months, otherwise a flat 10%. Unlisted MLDs are taxed as per investor’s marginal income tax rate if held for less than 36 months, otherwise a flat 10%.

Why are MLDs taxed at 10%?

MLDs are linked to the market (mostly, an equity index like NIFTY 50 or SENSEX). Because of this factor, MLDs are taxed lower - at 10% for more than 12 months (in case of listed MLDs)

Risks of investing in MLDs

MLDs are subject to the same risks that other bonds are subject to. These are credit default risk, reinvestment risk, interest rate risk and liquidity risk.

In addition to these risks, MLDs are also subject to an external benchmark risk of a specific asset and hence market risk of the asset class.

Advantages of investing in MLDs

The biggest advantage of investing in MLDs is the better tax treatment they enjoy than other types of bonds and debentures.

What are the best market linked debentures in India?

Here is a framework to find the best market linked debentures (MLDs) for you in India. 

First, you should invest in MLDs where the issuer credit rating aligns with your risk profile. If you are a low risk investor, stick to AAA or AA rated MLDs only. Second, the best MLD for you will align with your investment timeframe. MLDs typically don’t have interest payments. Hence, you need not worry about reinvestment risk. But that also means that they are more volatile than normal bonds.

But MLDs have a different risk that other Bonds are not subject to - market risk. You should have confidence that the benchmark will move against you. This may require an additional study of the asset class the benchmark belongs to. Hence, we recommend retail investors to stay away from MLDs and invest in them only under expert guidance.