Even individuals who are financially educated can fall for misleading investment claims due to selective disclosure by certain investment product makers. When only the positive aspects of an opportunity are presented while downplaying or omitting the potential risks in marketing, one might not dig deep enough to uncover these hidden risks —a case in point being recent market-linked debenture (MLD) offerings.

MLDs have seen a key taxation change (now taxed at marginal income tax rate) and minimum investment has been lowered to ₹1 lakh (for privately placed debt). Hence, one can anticipate more such offerings targeting retail investors who will need to watch out for similar illusory claims. Here’s a guide.

‘Assured’ illusions

Market-linked debentures (MLDs) are a type of quasi-debt/hybrid instrument that offer returns based on the performance of an underlying market index (Nifty 50). They are issued to raise funds from investors who are willing to take some market risk for higher returns. But the recent trend of MLD issuers marketing the offerings as some godsend financial investment opportunity is problematic. Use of terms such as ‘minimum assured 14% returns at maturity’, ‘100% principal protection at maturity’, ‘zero downside risk’ is misleading, because they only portray half-truths.

Terms such as ‘minimum’ and ‘assured’ along with a number, 14 per cent return in this case,are wrong. Debentures are a loan to a company, and if the company defaults, there is no certainty that you will get your money back, even if the debentures are secured. Secured debentures are backed by some sort of collateral that can be seized to repay creditors in the event of a default, but the seniority of the instrument will define the priority in which a firm in bankruptcy pays the debt claims. So, selling risky products as ‘assured’ returns or ‘zero downside’ is deceptive.

Digit deception

The brazen use of specific returns in MLD marketing collaterals is also audacious. For many retail investors who have kept money in bank FDs or bonds, double-digit returns are very appealing. In some recent MLD issuances, the use of ‘14% return’ without the mention of ‘absolute’ is manipulative.

As an example, an individual might consider a debenture that promises a guaranteed 14 per cent return to be an attractive investment. Nonetheless, it’s important to note that this 14 per cent return is realized upon maturity after a span of two years. Consequently, when calculated on an annualised basis using XIRR formula, the effective return amounts to approximately 6.6 percent per annum, which is similar to traditional, and actually safe, avenues such as bank FDs.

For instance, two-year post office time deposits (7 per cent) and one-two year mainline bank FDs (6.25-7.8 per cent annually) offer decent gains and more than floor returns of MLDs. Thus, the use of ‘14% return’ in MLD marketing brochures/websites was possibly done with an intention to misguide retail investors.

Liquidity lingo

MLDs are infamous for being illiquid. Even though they are listed on the stock exchanges, hardly any such instruments trade. So, the ability to liquidate the MLD and convert it into cash before its maturity was always tough. To counter these genuine concerns, recent MLD issuances have started promoting their ‘Anytime Liquidity’ facility.

Apparently, this feature offers liquidity to investors any time — starting from 7 working days after the close of an issue, until its maturity. But the marketing materials make only a passing mention of the high cost of this ‘anytime liquidity’. Dig deep and you will find the facility is available at a cost of 2 per cent of the total amount liquidated, which is quite high. If you earn about 6.6 per cent and pay 2 per cent of the total amount for liquidity, then your effective pre-tax return would be even less.

Risk-o-nomics

There are no free lunches in this world. If an MLD offers you the potential to earn, say, 30 per cent absolute gain in two years and a floor (minimum) return in case things go awry, remember they are not doing any charity. In the financial world, everyone is out to make money. So, investors must understand the risks fully.

One, in a Nifty-linked debenture, your downside cannot be zero because there will always be a risk of default.

Two, certain MLD investment opportunities provide principal protection solely under the condition that the investor maintains their investment throughout the entire product’s duration. Therefore, exiting the investment prematurely, or in what can be termed as the interim period, would nullify the guarantees.

Three, MLD pricing may not accurately reflect market movements. The value of an MLD (Market-Linked Debenture) product is impacted by the performance of its associated market component, which is directly tied to the underlying index or instrument. Nevertheless, due to the hybrid character of the product, the market component’s fluctuations are consistently less pronounced than those of the underlying market. This divergence persists until the product reaches its maturity date.

Finfluencer follies

With social media becoming a permanent fixture in young people’s lives, MLD issuers have been using financial influencers or ‘finfluencers’ to heavily promote products. Often, these ‘experts’ are paid a fee for their service, so understand the ‘product reviews’ or contextual mentions in videos, reels and threads, etc., are not impartial.

While many finfluencers aim to provide helpful and accurate information, there are instances where they inadvertently or intentionally mislead their audience. MLDs are complicated structures, but not all finfluencers are financial experts. Also, social media platforms often require concise content, which can lead to financial influencers oversimplifying complex financial concepts, resulting in inaccurate or incomplete information. Besides, to gain attention and followers, some finfluencers are using sensationalist language and exaggerated claims about the potential outcomes of MLDs.

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