The Art of Pledging: Unlocking Hidden Potential in Your Investment Portfolio (Part 1)

Introduction:

In the ever-evolving world of finance, savvy investors are constantly seeking innovative ways to optimize their portfolios and generate additional alpha. One strategy that has long been utilized by institutional investors, but often overlooked by retail traders, is the art of pledging existing holdings. This comprehensive guide will delve deep into the world of pledging, exploring how it can potentially revolutionize your investment approach and boost your returns.

What is Pledging?

Pledging is the process of using your existing securities as collateral to obtain additional funds or trading margin from your broker. These securities can include shares, ETFs, mutual funds, government securities (G-Secs), and other financial instruments. By pledging your holdings, you can increase your market exposure and trading capital without selling your long-term investments.

Below we have attached a sebi approved list of scripts eligible for pledging.

The Mechanics of Pledging:

1. Asset Eligibility:

Most brokers accept a wide range of assets for pledging, including:

- Equity shares

- Exchange Traded Funds (ETFs)

- Equity mutual funds

- Debt mutual funds

- Government securities (G-Secs)

- Corporate bonds

All the above qualify for pledging ref . document for exact script and their haircut percentage. 2. Haircut Application:

Brokers apply a "haircut" to the pledged securities, which is a percentage reduction in the asset's market value to account for potential market fluctuations. For example:

- Equity and hybrid funds: Typically 50% haircut (you get 50% of the value as margin)

- Debt funds: 20-30% haircut (you get 70-80% of the value as margin)

- G-Secs: As low as 5% haircut (you get up to 95% of the value as margin)

Illustrative example-

Let's say you invest ₹100,000 in a debt mutual fund.

1. Initial Investment:

   • Your initial investment is ₹100,000

2. Pledging for Margin:

   • Debt funds typically have a 25% haircut (you get 75% as margin)

   • Margin available: ₹100,000 * 0.75 = ₹75,000

3. Returns: a) On Initial Investment:

   • Your debt fund generates a 12% return

   • Return on ₹100,000: ₹100,000 * 0.12 = ₹12,000

4. b) Using the Margin:

   • Let's assume you generate a 6% return on the margin

   • Additional return: ₹75,000 * 0.06 = ₹4,500

5. Total Portfolio Value:

   • Original investment value: ₹100,000

   • Return on original investment: ₹12,000

   • Additional return from margin: ₹4,500

   • Total value: ₹100,000 + ₹12,000 + ₹4,500 = ₹116,500

6. Total Return:

   • Initial investment: ₹100,000

   • Total value after strategies: ₹116,500

   • Overall return: (₹116,500 - ₹100,000) / ₹100,000 * 100 = 16.5%

This ₹16,500 return on a ₹100,000 investment represents a 16.5% total return.

This example demonstrates how pledging securities with a haircut can potentially enhance returns. The initial 12% return from the debt fund is augmented by an additional 4.5% through margin utilization, resulting in a total return of 16.5%.

3. Margin Calculation:

The amount of margin you receive is calculated as:

Margin = Current Market Value of Pledged Securities - Haircut

4. Lien Marking:

When you pledge securities, a lien is marked on these units by the Registrar and Transfer Agency (RTA). This prevents you from selling or switching these units until the lien is removed. 5. Ownership and Benefits:

Despite the lien, you retain ownership of the pledged securities and continue to receive all associated benefits such as dividends, interest, and capital appreciation.

SEBI Regulations on Pledging:

The Securities and Exchange Board of India (SEBI) has specific regulations governing pledging:

1. 50:50 Rule:

For futures and options (F&O) trading, 50% of the margin must be in cash or cash equivalents, while the remaining 50% can be in non-cash collateral.

2. Approved Securities:

SEBI maintains a list of approved securities that can be pledged as collateral. Attached below

3. Margin Requirements:

Brokers must ensure that the total collateral value (including pledged securities) meets or exceeds the required margin for open positions.

Links-

Margin Pledge Stocks : Margin Pledge Stocks - List of Stocks Available for Pledge Margin | Dhan

Paytm : Paytm Money Stocks

EFTs : ETFs (kotaksecurities.com)

Haircut : Haircut - Mutual Funds (fyers.in)