Structured products gain in popularity as market volatility increases

Structured products are gaining in popularity as market volatility increases. These products allow investors to benefit from the market upside, while limiting their downside.

These products typically invest a majority of their capital in debt. The remainder is used to buy options on a benchmark index such as the Nifty. The interest income from the debt portion over a period of time covers the total principal amount, and any returns from the options acts as a booster for returns.

The net outstanding value of such issuances has risen to over Rs 23,068 crore as of the April-June quarter, shows the data from the capital markets regulator — the Securities and Exchange Board of India. It has more than doubled over a two-year period.

Deepak Chellani, head of third-party products in the distribution arm of broking house Prabhudas Lilladher, said there is demand for such structures in light of recent market correction. He said the returns are comparable to fixed deposits, even if market direction is not favourable, with an effective taxation of 10.8 per cent (long-term capital gains) on premature withdrawals. While allocations between debt and derivatives can vary, investors prefer higher debt allocations.

“Structured products with higher debt allocation, around 80 per cent, are more popular currently. They have lower capital allocated to equity options. This provides greater margin of safety and better risk-adjusted returns in certain scenarios,” said Chellani.

Prateek Pant, head of product and solutions at Sanctum Wealth Management, said such issuances tend to go up during periods of market volatility. “There are clients feeling quite nervy right now…with (the) type of events happening globally,” said Pant.

A March 2019 ‘Banking & Financial Services’ report on market-linked debentures (MLDs) from rating agency CARE noted that nine new companies across industries have incrementally resorted to raising capital through such instruments. This is to reduce dependence on short-term funding from institutions such as mutual funds.  Many companies had faced difficulties in raising capital, following tight liquidity conditions after the Infrastructure Leasing & Financial Services couldn’t meet its debt obligations last year.

“This has led to robust growth in MLD issuances. Despite this, MLDs form less than 1 per cent of assets under management (AUM) of private wealth industry (top 25 companies’ AUM, according to the Asian Private Banker/Wealth Manager report) in calendar year 2018, paving the way for huge growth opportunity in the future,” said the report authored by a team, including Senior Director Sanjay Agarwal.

The tenure of these instruments ranges between 13 and 60 months.

“Apart from Edelweiss group, India Infoline Finance Group and Reliance Capital Group companies, new issuers such as Aditya Birla Finance, Tata Capital Financial Services, Mahindra & Mahindra Finance, L&T Finance Group, Hinduja Leyland Finance, and Trust Capital Services issued MLD structures with government securities as the underlying reference index. Despite this, Nifty was the preferred underlying reference index for a majority (63 per cent) of the issuances in 2018-19 (to date). Centrum Financial Services, Kotak Mahindra Prime, Piramal Enterprise, and HDB Financial Services were the new entrants within Nifty as the underlying reference index,” it added.