Risks in Market-Linked Investment

What is a Market-Linked Investment?

A market-linked investment is a financial product whose returns are determined by the performance of an underlying market benchmark, such as a stock index, commodity price, or interest rate. Return will not be set or assured; it will move according to the market. The typical examples in mutual funds are equity funds, index funds, ETFs, and hybrid funds, all of which are based on the value of the securities found in their portfolios.

How It Works

The return on a market-linked investment depends on how the underlying asset or benchmark performs over a given period. When there is an increase in the benchmark, the investor benefits. If the benchmark declines, the value of the investment may fall.

To show this, a Nifty 50 Index-tracking equity mutual fund will represent the performance of its 50 diverse stocks. The Net Asset Value (NAV) of the fund is calculated daily based on the closing market prices of its underlying securities.

Types of Market-Linked Investments in Mutual Funds

The Securities and Exchange Board of India (SEBI) has grouped mutual fund schemes according to asset allocation and investment strategy. Index funds and ETFs, as well as equity and hybrid funds, are market-linked because they are priced according to market-priced securities.

• Equity Funds: These invest primarily in equity shares of companies and are highly sensitive to market fluctuations. They are suitable for long-term wealth creation.
• Hybrid Funds: They invest in a combination of both equity and debt-based instruments, such that market exposure varies based on asset allocation and risk level
• Index Funds and ETFs: These passively track indices such as the Sensex or Nifty 50 and seek to replicate their composition without active stock selection.

Risk Considerations

Returns are dependent on market performance, and therefore, capital protection is not guaranteed. Portfolio value is liable to change with economic, corporate, and general sentiments of the investor. SEBI requires mutual fund schemes to display a riskometer indicating the level of risk associated with the investment.

Tax Treatment

Capital gains taxation is based on the amount of the equity investment in the fund, and also on the period in which the investor holds the position:

• Equity-oriented funds (with at least 65% equity exposure) held for more than one year: Long-term capital gains (LTCG) are taxed at 12.5% on gains exceeding ₹1.25 lakh in a financial year.
• Equity-oriented funds held for one year or less: Short-term capital gains (STCG) are taxed at 20%.
• Debt-oriented funds (with less than 35% equity exposure) purchased on or after April 1, 2023, are taxed at the investor’s applicable income tax slab, irrespective of holding period.

These are the tax rates as regulated by the Income Tax Act and as amended by the Government of India.