High net worth investors are often wooed with exotic investment product offerings. One such product doing the rounds these days is non-convertible market linked debentures (MLD) from JM Financial Products. The MLD is a principal-protected structured product, with the 10-year G-sec price as the underlying reference asset. MLDs are complex products and so not suitable for retail investors, but high net worth individuals could explore them. Read our take.
In the current market scenario wherein the yields on even the AAA bonds are very low, JM Financial Products has launched a 24 month investment opportunity. The pitch is the product is capable of generating close to lower double-digit returns – also better post-tax returns – with just 24 months investment horizon.
We had looked at this issuer in August 2019 when it had come out with a public issue of NCDs. The company operates in four verticals to suit the needs of corporates, SMEs and individuals: Structured financing, Real Estate financing, Capital market financing, and SME financing. It has also ventured into real estate broking business.
The said MLD offering has the 10-year G-sec price as the underlying reference asset. The tenure is 23/24 months. The credit rating of the issuer company is AA (stable). Do note that JM Financial Products’ market-linked debentures are a structured product.
What is a structured product? A structured product is used to improve the return on a fixed income or an equity instrument.
The JM Financial Products’ market-linked debentures appear to be a lower risk design and can be plugged as part of ‘debt allocation’. That, however, doesn’t make the MLDs an easy instrument to understand.
The fact of the matter is MLDs are quite complicated and hence any investor wishing to invest in them must understand them in detail.
A structured product like MLD has pre-defined payoff scenarios. The payoff depends on the initial observation date and the final observation date.
In the case of JM Financial Products’ MLDs, the initial observation date is November 22, 2019, and the final observation date is 23rd month from the date of allotment (i.e. October 22, 2021). The final maturity/payout date is 24th month from the date of allotment (i.e. November 22, 2021).
Coupon – The MLDs offer a minimum coupon of 9.45% p.a. (annualised return calculated on XIRR basis). The maximum coupon is 9.50% p.a. (annualized return calculated on XIRR basis). Do note that in extreme situations, no coupon amount will be paid. Hence, the minimum coupon, in that case, could be zero. Coupon rates of 9.45-9.50% p.a. are quite attractive, a reason why investors may be interested in the first place.
Payoff factors – The MLDs are using the 10-year G-sec price as the underlying reference asset. So, the 10-year Government security price (Issue date October 7, 2019) has a Bloomberg Ticker called IGB 6.45 10/07/29 Corp.
As you can understand, the entire payoff is based on how the price of the 10-year G-Sec price will move. The price of security depends on how the interest rates will move. In general, when interest rates rise, bond values fall. When interest rates fall, bond values rise.
On November 22, 2019, the price of 10-year G-sec was 99.52 and yield to maturity was 6.52%. Now if the interest rates rise, that means the bond price will drop.
The payoff structure
1. Maximum coupon + principal will be paid when the price of 10-year G-sec is equal or more than 75% of 99.52 (the price on initial observation date i.e. November 22, 2019). So, essentially the IGB price will have to be equal or more than 74.64. For the bond price to fall, interest rates have to rise.
In this scenario, a Rs 10 lakh investment will be paid to you on maturity with principal plus a coupon of Rs 1,99,323 (9.5% p.a.).
2. Minimum coupon + principal will be paid when the price of 10-year G-sec is less than 75% but more than 25% of 99.52 (the price on initial observation date i.e. November 22, 2019). So, essentially the IGB price will have to be less than 74.64 but more than 24.88. For the bond price to fall this much, interest rates have to rise quite a bit.
In this scenario, your Rs 10 lakh principal plus a coupon of Rs 1,98,227 (9.45% p.a.) will be paid to you on maturity.
3. Only the principal will be paid when the price of the 10-year G-Sec is less than 25% of 99.52 (the price on initial observation date i.e. November 22, 2019). So, essentially the IGB price will have to be less than 24.88. This envisions a massive drop in bond prices and a consequent rise in interest rates.
In this scenario, only your Rs 10 lakh principal will be paid to you on maturity. No coupon will be paid.
Risk factors to note
* For an MLD to be tax-efficient, they need to do one thing – After the payoff is ascertained just before the maturity of the MLD, the investor should sell the MLD on the exchange close to the fair value. This ensures that his/her gains so realised are taxed as long term capital gains at 10%. The remaining amount of money is taxed as interest. This is as per our understanding.
Now, the debentures in case of JM Financial Products will be listed on the BSE WDM segment. However, the liquidity in the NCD might not be adequate or might be non-existent. So, there is a risk that the tax efficiency may be missed. The investor may not be able to liquidate or sell some or all of the debentures as and when they require. They may also not be able to liquidate or sell the debentures at the amount they want.
* The debentures proposed to be issued being principal/capital protected. However, the principal amount is still subject to the credit risk of the issuer. We have seen what has happened with AAA-rated NBFCs like Dewan Housing etc. Nobody today can foretell which NBFC will face risk next. The principal amount invested in any company is exposed to credit risk, whereby the investor may or may not recover all or part of the funds in case of default by the issuer. This is true even where the debentures are principal protected.
However, those who are ready to bear the credit risk (just in case a big default happens) and are willing to endure the illiquidity for 24 months, they can look at the option of investing in this for upto 9.5% coupon.
Disclaimer: Views expressed here in this article are for general information and reading purposes only. They do not constitute any guidelines or recommendations on any course of action to be followed by the reader. The views are not meant to serve as a professional guide/investment advice / intended to be an offer or solicitation for the purchase or sale of any financial instrument including debentures.