Introduction
With the high volatility in the stock market investors are looking for the investment option which can secure there principal plus provide the assured return to their investment. Equity linked Debentures(ELD) are structured products which protects the principal and provide the return which can linked to basket of stocks or index (like nifty or sensex). ELDs came in two types: (a) principal protected, where the principal amount is fixed while the interest component is variable and linked to stock market movements; (b) the more risky variant is the non-principal protected instruments where even the principal is linked to the market.
These types of structured products are generally sold to the sophisticated investor by the big financial institutions like Merrill Lynch, Deutsche Bank, Kotak etc. The issuer of these instrument investment the part of the money in fixed income securities which generate the fixed return thus keeping the principal intact and part in the equity which give the return of the stock market. Let see how the return is calculated for these instruments.
Say fund houses come with initial value of the nifty which is often the average. The value of nifty for 1, 2&3 is 4000, 4100 & 4200 respectively then the average value comes to 4100 which is initial value calculating the return. Now nifty value for 34, 35 & 36 months is 4500, 4600 & 4800 respectively, average is 4633. The return would be 4633-4100/4100= 13%. So return generated over a period of 3 years would be 13% if the participation ratio was 100%. Participation ratio is the ratio at which ELD participate in the appreciation process. If participation ratio is 100% and return is 13% then total payout on maturity would be Principal+ Participation ratio* Return generated by index which is principal amt.+13% return generated on equity.
Indian Scenario
Comparatively new debt instrument in the Indian market. In India these ELD are mainly issued by foreign financial institutions. Now nearly all the AMC are offering equity FMP plans which provides guarantee of principal amount of investor with upside of equity. All these fund are close ended and there expense ratio is only .25%-1% but they discourage premature withdrawal by charging high exit load of up to 3 Popularly know as capital protection funds, mutual funds are now making these products available to retail investors as well. ICICI Prudential asset management company (AMC) launched their Nifty-linked FMP a closed-ended product and now Deutsche AMC has launched a similar product.
Although these ELD’s generates higher return than traditional FMP’s but financial planner & portfolio managers of the view that an investor can generate the same return or higher return if simple portfolios of stocks and bonds can be purchased and periodically. These products add nothing to retail investors’ portfolios that can’t be acquired from investments “already available in the market in the form of less risky, less complicated, or less costly products” and therefore fail the “reasonable-basis” suitability requirement for sale to retail investors.
