Heads I Win, Tails I Don’t Lose!

      No Comments on Heads I Win, Tails I Don’t Lose!

Lets say for example you believe there is an 80% probability of the Nifty crossing 12500 in the next 3 years and you want to remain invested but near term volatility is scaring you. You ideally want a product where you get this upside if you are right but get to protect your capital if you are wrong. One option would be to try and create this yourself by buying (expensive) 3 year Nifty Call 11000 Strike option and buying a fixed deposit as well – the interest from the fixed deposit would pay for the premium that you spent  on buying the option and your capital would  be fully protected as well. The issue however – where do you buy this option from?

Also each persons objectives may be different – someone may want leveraged returns (meaning if Nifty does 40%, one wants 50% even with reduced capital protection) or someone may just want FD Plus returns.

Introducing Structured Products

This is where Structured Products come in. Structured notes are designed to bridge the gap between the safety of bonds and the return of equities

Almost always available with a minimum size of Rs 25 lakh,  Structured products are Investment instruments that can be customized to suit an investor’s risk return profile. These products typically help the investors to implement their investment ideas in various scenarios.

The Returns on these are based on an underlying – Index, Stocks, Commodities or Basket of Stocks. Because they are “structured”, they typically cater to meet specific objectives – mostly capital protection with participation in upsides – and have become very popular with HNIs since 2008 when they first made their entry into India with MNC banks launching these for the super rich private banking individual and treasury clients. Structured products (SPs) can help investors cope with changing market conditions, as they can be tailored to suit their market outlooks.

All Time Highs

2017 saw the issue of the largest volume of what is called Nifty Linked Debentures (NLD) at close to Rs 8000 crs (previous year Rs 4600 crs). The highest quantum of structured products are sold as NLDs in India (84% of these NLDs were capital protection oriented and 20% of these were issued against other instruments like G Sec yields etc)- showcasing that this is becoming a large alternative investing  space in the country with HNIs.

The issuers of these NLDs are all well known NBFCs which borrow money from you via these instruments and instead of paying you interest, are committed to paying you variable coupons as a structured return. These bonds are bought off and packaged by Alternative Investment Funds or PMS Providers and then retailed to us OR if these are very large treasury tickets, then deals are done directly.


Different type of SPs

SPs can typically be defined as belonging to three different categories:

The first is the capital protection SP; this is typically created on low volatile underlying assets or a combination of debt and equity. It allows the investor to participate in index or basket upsides but with a full capital protection upto a certain level.

The second SP would be classified as yield enhancement product. It is usually used on volatile underlyings, such as individual equities, indices and commodities. Investors receive a fixed guaranteed coupon/yield (the upside), while combining a partial downside protection.

The third category is the participation product. It allows the investor to achieve more upside with some but reduced downside risk inherent to underlying asset; or the same upside with less downside exposure. These products are usually equity replacement ideas.


Structured Products Jargon

Participation Ratio is the ratio at which the NLD participates in the appreciation of the underlying equity index (eg Nifty) o E.g. Participation Ratio of 100% implies that a 10% increase in the Nifty will result in a final equity-linked coupon of 10%

Knockout/Barrier levels: It is a predefined level. These levels cap the participation in underlying index. Once these levels are achieved/hit, then predefined % participation will be given o E.g. Barrier level is 180% & Knockout returns is 60%, which means if Nifty gains by more than 80% as per closing/final NAV/Value, then participation ratio will be void and knockout returns of 60% will be paid to investors.

Returns Observation Dates: Calculation of Returns are typically not on a point to point basis and are calculated as an average of several opening and closing months and  not just a specific date

Participation ratio : The extent to which your bond will generate coupon yield basis movement of the underlying asset. That is. If Participation Ratio is 120% then NLD returns would be 120%*44.67%(Nifty Returns) = 53.60% over 3yrs

Things to Remember

The primary and most critical risk linked to structured products is credit risk or the risk that the issuer may default. The product, basically an NCD, is issued by non-banking financial companies (NBFCs). It is, thus, rated as a debt instrument from that NBFC and carries the same risk of default and non-payment of coupon as other debt instruments. This essentially means you take the risk, irrespective of it being a capital-protected structure, that the issuer may not be able to pay you back.

The asset risk comes from the derivative part of the product. Each structure is designed to cater to a specific view on the price movement of the underlying asset. If the underlying asset is the Nifty, a 36-month structure may be designed to cater to the analysis that the Nifty most likely will return up to 5% during the tenor, another structure may be designed to cater to the view that the Nifty will double the returns. Participation rate, coupon and other relevant features vary accordingly. Before you subscribe to a particular structure, you need to have an idea of where you think the Nifty level will reach at the end of the tenor. This will determine the final payout you are willing to accept.

Also, Equity linked debenture schemes do not allow premature exits. All benefits are subject to investment being held till redemption date.

These products, though listed on the exchanges, are a bit illiquid and hence difficult to sell or transfer.

In certain cases, the issuer or arranger of the notes may offer to buy back the notes at a certain cut-off.


Despite the risks, this product has a unique proposition, which allows you to make money regardless of the volatility in asset prices. Moreover, even if the underlying asset is in a rally, the participation rate of more than 100% means that you make more returns than if you invest directly in the underlying asset. Structures which offer a fixed coupon are also very attractive as the payoff is certain and that makes sense in volatile markets. Moreover, structures with capital protection mean that there is no downside in the product itself.

You have to have some idea about which direction you think the underlying asset prices are headed and ask for a structure around that view. A product may be geared to take advantage of a 15% rise in the Nifty after three years, whereas you are actually expecting at least a 30% rise; in this case, you may not make any money if there is a knock out when the Nifty rises by 20%.

Also look at the product on an overall basis – A product that offers a participation of 200% isn’t necessarily better than a product that offers a participation of 150% because credit rating, knock out barriers, coupon and tenor all should be considered. There will always be an offset amongst these features.

Talk to Us

Prabhudas Lilladher has a specialized unit at Mumbai which talks to NLD / GSecD providers and can help you with specific structures or products that will almost always certainly outperform fixed income products. These products are especially suitable for treasuries , HNIs and fixed return investors.

Do ask us for a call or meeting by emailing us at mfss@plindia.com or call us  at 022-66322366 to ask for meetings with Deepak Chellani, our Head of Third Party Products .



Leave a Reply