Introduction

To differentiate between two financial products, you must first get a conceptual understanding of what the products mean for the investor. It is then you gauge the pros and cons of both the instruments. 

When you get a clearer picture of how two products work, you get clarity on what to choose. This way, the hazy picture you may have had or the dicey opinion you may have had to choose products vanishes.

Approaching a financial manager to discuss two different investing products can be one way of looking at it. Otherwise, you can read well-defining blogs that help you differentiate between two products to eliminate confusion or dilemma on what to choose. 

On this note, let us cover equity-linked note vs convertible bond by also giving you a glimpse into how the basics work. 

What are equity-linked notes- Meaning and conceptualization explained

An equity-linked note is a structured product wherein the returns are linked to the performance of equity-based assets. The asset allocation comprises single or independent stocks or a basket of securities. 

Equity-linked notes also known as ELNs might offer partial or no principal protection as the upscale potential on the notes to make income depends on the performance of equity-linked assets the notes are exposed to. 

However, some ELNs come to you with complete capital protection. These are capital-guaranteed or principal-protected elns. The ELNs offer periodic coupon payouts or some may not offer coupons and the flexibility of elns to offer periodic payouts depends on the structure with which they are curated or designed for investors. 

The payoffs usually happen at the time of maturity of the investment portfolio and the payout structures may not be fixed or determined as the final payouts are arrived after looking at the performance of underlying equity assets the notes are linked to. 

Various factors like caps, floors, leveraging elements, or interest ratio changes can play their role in determining the final payouts with respect to ELNs. 

What are convertible bonds- Meaning and Conceptualization explained

Convertible bonds refer to corporate bonds wherein investors have the opportunity to convert their bonds into underlying shares of the company’s stocks. These are a specified number of the shares that are underlying within the issuing company’s stocks that investors get while the investment portfolio is about to mature or get redeemed. 

Convertible bonds fetch investors with capital protection as the bonds get converted into equity shares or can be redeemed at their face value as well. Interest payments are usually made to investors in the form of periodic payouts as coupon payments. These bonds provide higher-value investment options to investors as the bonds convert into equity-based shares at the time of redemption of the asset portfolio. 

With respect to convertible bonds, the capital or principal investment of the bonds converts into equity shares at predetermined ratios and the investor can choose amongst underlying stocks of the product issuing company with whom he has signed up.

You must also have a thorough look at the outlined terms and conditions as specified in the bond agreement to understand how the conversion may take place at the time of redemption of the portfolio. 

Equity-linked Note vs convertible bond- Key differences explained

Let us understand key differences covering equity-linked note vs convertible bond. Helping you through with a run-down into the same:

1. Exposure
   

Equity-linked notes are debt instruments directly tied to the underlying performance of equity-based assets the notes are linked to. These are structured products that come to investors with varying degrees of risks and return components. 

Whereas, convertible bonds comprise a neat or optimal mix of fixed-income securities with an upside potential to equity. The investors get their equity shares of the company’s underlying stocks while the portfolio is about to get redeemed.

2. Principal-protection
   

Convertible bonds offer better principal protection as against most types of ELNs. This is because convertible bonds are corporate bonds that have a blend of fixed-income securities. 

On the other hand, most ELNs are linked to the performance of equity-based assets. Therefore, the upscale income plus principal redemption primarily depends on the performance of underlying equity-based assets or derivatives these notes are linked. 

Therefore, investors may lose a partial or complete value of their capital investment if the underlying assets do not perform so well in the market and therefore fail to reach their buffer or strike rates as set on the notes while they were initially designed or curated for investors as such. 

3. Flexibility of interest/ coupon payouts
   

Coupons payouts for equity-linked notes are not fixed or pre-determined in nature. This is mainly because the potential returns of these notes are primarily linked to the performance of the underlying assets that the elns are linked to. 

When assets meet pre-designed conditions that outline the terms of the eln, then investors are paid out their capital investment and coupons the investment portfolio earns throughout the term of the asset. Therefore, returns are not fixed or pre-determined for elns. 

With respect to convertible bonds, investors are eligible to receive periodic interest payments or coupons as stated on bond-related disclosure agreements. These coupons are usually fixed or pre-determined in nature. 

4. Return structures
   

The return of payout in terms of principal investment and coupon-based interest earnings is quite complex with respect to equity-linked notes or elns. This is primarily because the notes are linked to the performance of underlying assets which are shares, stocks, or equity-based derivatives. Therefore, the assets are subject to volatile market conditions and the prices of assets may rise in a bullish market while taking a downturn in bearish market scenarios. 

As the assets of underlying elns comprise rising or falling prices/ values, the returns in terms of final payout structures are not fixed or pre-determined for the investors.

Whereas, in the case of convertible bonds, the returns are more straightforward. You can convert bonds into equity-based shares or collect your final payouts in the form of cash settlement comprising your principal investment and returns in the form of coupon-based interest earnings.

The conversion price at which the bonds convert into equity-based shares or stocks will be mentioned on the disclosure documents or you may discuss this with the investment manager or banker with whom you have signed up. 

The Bottom Line

In a nutshell, you can fairly conclude that ELNs are customized structured notes that are linked to equity-based derivatives with varying degrees of risks and payout structures. 

Whereas convertible bonds relate to fixed-income securities that have an optional convertibility to equity-based portfolios for the investors.

Above all, each investing plan comes to you with risks and disclosures. You must therefore read the offer documents thoroughly before investing.

Frequently Asked Questions- FAQs