What are Structured Products?
Structured products are a combination of an underlying investment (equities, currencies, bonds, commodities) and one or more derivatives that are structured into one financial instrument. These investment instruments can be tailored specifically to a client’s exact market view in order to match their chosen risk profile and return expectations. They are an extremely beneficial investment instrument and nowadays they play a very significant role in many clients’ portfolios.
Structured products are flexible instruments providing clients with the possibility to structure their investments to meet specific financial goals. The terms are bespoke to meet client demand, hence the terms, return payoff and risk profile are extremely customizable.
They are typically structured around a single line of stock / equity, a basket of equities, an index, a commodity or currency.
Structured Products have the following key benefits:
- Varied, diverse investment opportunities
- Tailor-made structures in relation to a clients’ particular risk / return ratio and requirements
- Formula based with pre-defined terms
- Cost efficiencies can be achieved through the combination of a diverse range of financial components
- Secondary market liquidity
- Prompt deployment and implementation of bespoke investment strategies
Types of Structured Products include:
Capital Protected Products:
Capital Protected Products offer (partial) protection of the initial invested amount (usually between 90% and 100%) at maturity, subject to the credit risk of the issuer. In addition, they offer a return potential linked to the performance of an underlying asset, in the form of participation, a recurring payment, or a one-off payment at expiration. Capital Protection Products are suitable for risk-averse investors.
Yield Enhancement Products:
Yield Enhancement Products offer a limited (capped) upside, usually in the form of a fixed coupon. Investors sacrifice an unlimited participation in favour of a recurring or one-off payment. Yield Enhancement Products may offer conditional capital protection, in which case the protection is granted only if a pre-defined level / price is met. These products are suitable for investors with a moderate to increased risk appetite.
Participation Products offer usually participation in the performance of one or multiple underlying assets. Participation Products are subject to the credit risk of the issuer. These products are suitable for investors with a moderate to increased risk appetite.
Leverage Products provide the opportunity to generate leveraged profits while making a relatively small initial investment. The risk of Leverage Products, though, is a total loss of the initial investment. Leverage Products are therefore only suitable for investors with a high risk appetite. Leverage Products can also be used to hedge risks, in which case they reduce the risk of a portfolio.
What are the risks?
Risk of Loss: in some structured products you risk losing a proportion or all of your initial investment. Sometimes this risk is somewhat mitigated against a drop in prices to a certain level (typically 50%). This is often referred to as “soft” protection. However, if share prices drop beyond this level the protection is cancelled, meaning that you will most likely lose more of your initial investment amount.
Caps: many structured products have an upper limit on the maximum possible return available. This means that if underlying stock / index price performs very well throughout the term of your investment, your particular investment return may not perform as well as the underlying and you may receive a lower return than you would have if you had just purchased the underlying asset directly (i.e. a stock or index).
No Dividends: Structured Products typically do not pay dividends.
Finally, your funds should be committed for the full term of the product. You need to be reasonably certain that you will not need access to your invested funds earlier. Some issuers may permit investors to withdraw their funds early, but the encashed value will reflect current market conditions and prices, and since fees and charges are normally taken upfront, you may get back less than you invested.
Structured Products should be simple to understand. As with all investment decisions, speak to your advisor to see what are the most suitable structures available to meet your specific requirements.
Gerard O’Brien LL.B LL.M CFP® QFA is a Certified Financial Planner and the Owner of Heritage Wealth, a Financial Planning practice based in Main Street, Midleton, Cork. For more information, contact Gerard at firstname.lastname@example.org www.heritagewealth.ie
Disclaimer: All data and information provided within this article is for informational purposes only. Heritage Wealth Management Limited makes no representations as to accuracy, completeness, suitability, or validity of any information and will not be liable for any errors, omissions or delays in this information or any losses, injuries, or damages arising from its use.