What are structured products?
It’s a complex investment product. It can be said to be a portfolio of simpler investment instruments put together according to the investment strategy set at the time of the creation of the structured product (SP). Most often, an SP is a combination of traditional instruments: stocks, bonds, CDs, and more risky futures contracts and options. The result is a non-traditional investment product with unique characteristics that could not otherwise be obtained by a private investor. For example, you can buy an SP that is made up of shares but also receive a fixed coupon on a quarterly basis, if the product’s investment strategy conditions are met. There are also SPs with investment protection, where part of the strategy implementation is that the investor cannot lose their initial investment in whole or in part.
How to invest in structured products?
Typically, SPs are issued by investment banks and sold through agents such as brokerage firms or asset management companies.
We can highlight two types of structured products:
- Structured transactions
In this case, you enter into an agreement directly with a broker, asset management company, bank, or an insurance company. All conditions, including loss and income, are stipulated in advance in that agreement. It’s also a term agreement, as it is valid for a certain time period. Early termination entails additional risks and losses for the investor.
- Structured securities
In this case, you purchase securities on an exchange or the over-the-counter market. The terms of their maturity, expected income, and potential losses are specified in the prospectus. Theoretically, you can sell your securities at any time, but you should always keep in mind that these instruments are extremely illiquid. Typically, in this option, SPs are in the form of structured bonds or structured notes.
What are the benefits of investing in structured products?
- High expected profitability
As the SP’s “portfolio” contains derivatives, the investor can make a significant profit at the expiration of the structured product, even if the stock market has not moved much during that time.
- Investment protection
The terms of many SPs guarantee full or partial return of the original investment.
- Low minimum investment threshold
The investor can use an SP to invest in instruments that are usually available only to very wealthy market participants.
- Ease of use
As part of owning an SP, the investor does not need to put together a basket of securities, create a strategy, and monitor the market on his own. All the terms of the structured product are stipulated in the agreement or prospectus.
What are the main risks of investing in structured products?
Early termination of the agreement always entails additional risks for the investor. In case of an early withdrawal, the investment protection is not in effect. Exchange-traded notes are traded in the market, but even so, it will be difficult to find a buyer at a good price.
- Issuer credit risk
If the company that issued the product goes bankrupt, the risk of losing all investments is extremely high. If the SP issuer is a foreign company, the investor will have to litigate in another country, which is quite costly.
- The risk of losing potential income
As a rule, SPs limit the potential income. Therefore, there is always a possibility that the underlying assets will ultimately show higher returns than the linked product.
- Inflationary risk
Even with a 100% initial investment return guarantee, the full amount received a year later will have lesser purchasing power than originally. Keep in mind the time value of money when considering all the other SP terms.
Structured products are extremely beneficial for the issuer who makes money in any event and can charge high commissions when buying or selling notes. Therefore, an investor should exercise extreme caution when choosing this instrument. Catchy ads which highlight only the positives can prove costly for a stock market newbie. SPs are complex financial instruments available to qualified investors only, which is why we advise you to entrust your funds to a reliable asset management company.