Structured Products

Structured products are financial instruments issued by banks and other financial institutions containing varying terms, payouts and risk profiles tracking the performance of an underlying asset which can be equity, index, commodity, currency or a basket of various products.

Structure products are tailor-made products that are issued keeping in mind the risk-profiles of issuing bank’s customers and hence they may differ significantly from the structure products issued by competing banks. They are designed to provide investment solutions for a particular risk-profile or group of investors and hence proper study should be made, before investing, about their features and payouts. Since they are not standard products, they can be designed to provide investment solutions for varying degree of risk and return, which might not suit all types of investors.

The selection or creation of a desired structure product needs to be made within a portfolio context and should suit one’s overall asset allocation, investment horizon, and risk appetite.

Types of Structured Products

There are four broad categories that structured products fall into. The terms used may vary slightly from one issuer to the next.

1. Capital Protection
2. Yield Enhancement
3. Participation
4. Leverage

Capital Protection:

As the name suggests, the products that fall into this category are designed primarily to provide capital protection to the investor. The capital protection can be either full or partial. In case of a full capital protection, the capital invested is repaid at maturity if the product fails to deliver the expected results. In case of partial capital protection, the capital invested is repaid partially (as per the terms of the product – e.g. 80% or 90%) if the product fails to deliver the expected results. Some instruments offer conditional capital protection which is commonly linked to the performance of the underlying asset. If specific conditions are met, for example if the price of the underlying asset falls below an agreed threshold, the capital protection disappears and the investor may incur a loss at maturity. These products are suitable for risk-averse investors. They can be structured to perform in rising or falling markets and should be chosen in accordance with market expectations over the lifetime of the product.

Yield Enhancement:

These products are designed to provide yield enhancement and are offered as an alternative to fixed income securities. They, usually, do not offer capital protection. The aim of the products that fall into this category is to generate a return higher than that of other investment options generally considered less risky such as a bond. Some of the products offer coupons and have features similar to bonds, but their risk-profile and payouts are different to that of a bonds or fixed income securities. These products are suitable for investors with a moderate to increased risk appetite and the expectation of markets moving sideways over the lifetime of the product.

Participation:

These products usually offer unleveraged participation in the performance of one or multiple underlyings. Participation products may offer conditional capital protection, in which case the protection is granted only if a predefined condition is met (i.e. barrier has not been touched). Participation products are subject to credit risk. These products are suitable for investors with a moderate to increased risk appetite. Market expectations should be a directional move (up or down) over the life time of the product.

Leverage:

They provide the opportunity to generated leveraged profits while making a relatively small initial investment. The risk of these products, however, is the possibility of a total loss of initial investment. Thus, these products are suitable only for investors with a high risk appetite. Leverage products can also be used to hedge risks, in which case they reduce the risk of the portfolio. Market expectations should be strong up or downward movement and the products are best used as short-term speculative investments requiring daily supervision or as a hedge.

Benefits of Structured Products

The following are some of the benefits of using structure products.

1. They offer simple and cost effective access to a wide range of markets.
2. They are traded in the same way as ordinary shares
3. They can be provided either geared or ungeared performance
4. They can provide potential return even when the performance of the underlying asset is static, positive or negative.
5. Some structured products have built-in currency risk management features
6. The maximum potential loss is usually known in advance in these products.
7. There are no margin calls associated with these products.
8. Usually, these products have transparent, continuous on-screen pricing throughout the day.
9. There are market makers who are committed to providing a liquid market so that investors can trade in and out of their positions before maturity.
10. There is a high level of regulatory oversight and disclosure.
11. There is usually no requirement to provide instructions to terminate the product at maturity. Most products are terminated automatically at maturity, if held to maturity.
12. There are, usually, no stamp duties or SDRT (Stamp Duty Reserve Tax)