The PPMLD product
Principal Protected Market linked debentures (PPMLDs) are instruments whose return are linked to the movement of an underlying market variable like an equity index/basket of stocks/stock/commodities. ‘Principal Protected’ implies that the investor is assured to at least get back the invested principal amount. Most of the PPMLDs, issued so far in India, are linked to National Stock Exchange’s S&P CNX Nifty index, with an average tenure of 2-3 years. The structures vary depending upon the appetite of the investors whether they want to take a bullish / bearish call over a range of Nifty values. These instruments are typically issued by NBFCs and are generally sold to sophisticated investors/HNIs by corporate distributors such as private wealth management units of banks/NBFCs.
The PPMLDs draw elements from both Equity and Debt. PPMLD protects downside risk just like debt instruments (bonds/G-sec/FMP plans). However, instead of a fixed interest rate, PPMLD provides returns based on the movement of an underlying market variable, giving market linked returns. Typically there is a “participation ratio” that indicates the return that investor will get if the underlying moves by some percent, over a range of values. For e.g. if participation ratio is 1.2 times and if the nifty moves up by 10%, investor will get 12% return over a range of nifty values.
The average return on PPMLDs is estimated to be between 13-17% pre-tax yield v/s. 8-9% pre-tax yield generated by banks FD/corporate bonds. These products have the capability to offer assured/predictable return in bearish/bullish equity market scenario depending on the structures. The unique feature ‘upside gain potential coupled with down side risk protection’ of PPMLDs offers a hybrid investment option for HNIs in addition to equities and debt.
Issuances of PPMLD
The number of issuances in MLD market has reduced to only 16 in Dec 2012 vis-a-vis 27 in Nov 2012. The reduction in issuances is primarily on account of lower issuances from large players like ECL (Edelweiss Capital Limited), RCL (Reliance Capital Limited), Citicorp. It is pertinent to note that most of the issuance (~96%) have Nifty index as their underlying asset and the remaining 4% have different underlying assets (such as basket of stocks - Citicorp and Credit Suisse, MCX gold index – Karvy). Furthermore, the issue-size of few PPMLDs structures moderated to less than Rs. 25,00,000 due to 1) subdued investors’ sentiment, and 2) investors preference towards other inflation hedged asset class. CARE Research observes that volume-wise (no. of issues) ECL has been the leader, followed by RCL, Citicorp, Karvy and Macquarie during Oct 2011- Dec 2012 period. Since, the terms sheets for most of the recent issuances are not available in public domain, it is difficult to calculate the issuer-wise total issuance (in terms of value) in market.
Benefits to the Issuers
The issuers (typically NBFCs) offer such structured products primarily to 1) diversify their funding sources, 2) lower the cost of borrowing with hedging mechanisms in place, and 3) tap wealthy class of investors (HNIs). CARE Research observes that due to the gaining popularity of this product among retail/corporate investors two new NBFCs, IIFL (India Infoline Finance Limited) & MOFSL (Motilal Oswal Financial Services Limited), have entered into this space recently, taking the total number of active issuers to 17.
Some Risk Factors to Consider
MLD structures are complex market instruments that do not provide a simple, plain vanilla return to the investor. Often the returns are different over a range of underlying value and may not follow a simple direct correlation with the market. In some instruments like autocallables, the tenure of the return of the instrument may get fixed after market reaches a certain level. The market regulator SEBI has also considered the importance of these factors and has authorized rating agencies like CARE to do an independent valuation of these structures. CARE has set up a dedicated desk that uses advanced industry recognized simulation software and data to provide weekly valuation of these structures. Apart from the valuation provided by CARE, investor should also look at the credit rating of these instruments done by CARE which are issued with a suffix ‘PPMLD’ in the rating symbol.
Enhancing the reach of PPMLD (to retail investors)
CARE Research noted that the issuance of PPMLD have gone down significantly during Sep 2011-Apr 2012 primarily due to 1) increase in the Minimum amount of investment under portfolio Management Schemes (PMS) from Rs.5 lakhs to Rs.25 lakhs (In an attempt to strengthen investor protection by SEBI) 2) lackluster performance of the domestic indices and 3) SEBI’s requirement for an independent valuation of the PPMLDs by rating agencies.
CARE Research believes that increased accessability to PPMLDs, improving equity market and reduction in interest rates will bring in more funds to PPMLDs and issuances will witness better demand. Furthermore, with most issuers in compliance with the September 28, 2011 guidelines for listing, rating and valuations of PPMLD’s they are all set to tap the increased PPMLD appetitie with various structures in the market.
CARE Research suggests that the regulator may consider retail investors participation in these structures by allowing issuances in form of units similar to mutual funds. Nevertheless, the regulations have to be stringent enough to protect the retail investors. The regualtions may, enteralia, include approval and disclosure of hedging mechanism, timely reporting, valuation disclosures to name a few.