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With key policy rates expected to head southwards in the coming months, wealth managers have started hawking capital-protected interest rate-linked structured products to wealthy clients. This is the first time such a product has been floated in the Indian market.
Edelweiss Capital, ICICI Securities and IIFL Wealth Management were among the firms to have hit the market with this product just a few weeks before the Reserve Bank of India (RBI) cut the repo rate by 25 basis points last month.
These firms together have mobilised between Rs 50 crore and Rs 75 crore and more wealth management firms are looking at launching similar structured products, industry players say. The product is a form of secured non-convertible debenture (NCD) and targeted at high net-worth individuals (HNIs) with a minimum ticket size of Rs 25 lakh. There is an 18-month lock-in but investors get an option to sell before this period as the instruments are listed on exchanges. The returns are linked to the 10-year benchmark government security (g-sec) yield for a point-to-point 15-month period.
“We wanted to look at a tax-efficient structure that would give investors an accelerated upside while protecting the principal on the downside,” said Ashish Kehair, head – private wealth, ICICI Securities. “We got the timing right. The interest rate cycle had peaked and inflation was on a downtrend, so a rate cut was imminent.”
IIFL and Edelweiss did not respond to emails.
Here's an example of how the returns would be calculated. If the 10-year benchmark g-sec yield falls by 1 per cent or more after 15 months, investors get 1.25 times the capital gains along with a fixed 12 per cent coupon, amounting to total returns of 19.5 per cent. If the g-sec yield remains at the same level after 15 months, investors get the fixed 12 per cent coupon. If the yield rises by 50 bps, investors get 6 per cent but if it rises by 1 per cent or more, investors just get back the principal.
This product scores over direct investment in g-secs as the principal is protected and one does not suffer a capital loss if interest rates move up by more than 1 per cent. The disadvantage is that capital gains for the structured product are capped to the extent of 1 per cent of fall in g-sec yields.
“If interest rates were to fall more than 1 per cent, returns in g-secs would be better. Also, if interest rates were to rise by up to 1 per cent, returns from the product would be slightly lower than g-sec returns, ”said Raghvendra Nath, managing director, Ladderup Wealth Management. Also, while the units are listed, redemption before the lock-in period is difficult as liquidity is low.
The NCDs enjoy a tax advantage over gilt funds, which have to be held for three years to get the tax benefit. Gilt funds are taxed at applicable slab rates if held for less than three years and at 20 per cent with indexation otherwise. Capital gains for listed NCDs are taxed at 10 per cent if held for a year or more or added to your income if held for less than a year. Interest income of NCDs held to maturity is added to your income and taxed at the applicable slab rates. Gains from direct investment in listed g-secs are also taxed at 10 per cent if held for a year or added to your income if held for less than a year.
