While the range of structured products available around the world is broad and complex, in South Africa investors will mostly find the following kinds of products on offer:
Products with capital guarantees and participation in the return of the linked asset
An example of this kind of product is the FNB 100% Capital Preserver Participation 1 (ZAR), with a three-year term that offers 110% of the return of the MSCI World Index and a full capital guarantee regardless of how much the market loses.
The capital guarantees may also be partial and the participation in the return of the linked asset may be capped.
For example, Wealthport’s BNP Paribas Multi-Asset Diversified Enhanced Growth Endowment Series 3 offers a 200% participation in the positive performance of the underlying offshore asset capped at a return of 25%. This means if the underlying offshore asset returns more than 25% during the investment term, the investor’s maximum return would be 50%.
If the underlying offshore asset loses money, the participation rate is 50%, which means that if the underlying offshore asset loses 10%, the investor only loses 5%.
Products that pay enhanced yields
An example of this kind of product is Discovery’s Capital 200+ structured product, designed to deliver a return of 200% (double the capital invested after fees) if a basket of 20 top global stocks are at the same or higher level than when the investment term began.
If the shares return above 40% over the five-year term, then the return on the capital is 300%. If the portfolio of shares is up more than three times its starting value, the investor also enjoys the growth above that 300%.
If the portfolio is down up to 30% from the level it was at the start of the investment, investors will get their capital back before fees. If the loss on the portfolio is more than 30% on opening levels at any point during the term of the investment, investors will experience the full impact of the loss.
A coupon-driven product provides a predefined coupon when the reference asset is above a certain hurdle of performance. Yield-driven and coupon-driven products are priced differently.
According to Francois Strydom, portfolio manager at Momentum Securities, coupon-driven products price better in periods of higher volatility than the participation notes and vice versa. But both price well when interest rates are fairly high and the funding to obtain protection is high.
Participation structured notes
These products allow investors to participate fully in the markets’ ups and downs. An exchange traded note is a structured note that provides full participation in the underlying asset or index.
For example, UBS has a structured note that participates in the Solactive Robotics & Drones Net Total Return Index that tracks the performance of companies in the robotics and drone industry.
Auto calls
An auto call structured product includes an option that can be exercised at various times during the product’s term. For example, the term may be five years, but the product will mature and pay investors out if the underlying index is positive in year three, four or five.
For example, Investec has a ZAR Euro Stoxx 50 Autocall listed on the JSE with a maximum five-year term that pays a minimum return of 14.5% a year if the index is flat or positive over the term on predetermined call dates.
It offers 100% capital protection provided the index has not fallen more than 70% from the starting value at maturity date.
A digital or an auto call is a predefined coupon based on the reference asset performing better than a particular hurdle rate. That hurdle rate could either be that the index is flat or up by a certain amount or it should not be down by more than a certain amount.
It makes use of options that are bought and sold to provide the level of protection and the return.
A digital pays out if the reference asset is at or above a specified level. It is called this because of the “digital” or “binary” nature of its pay-off; you either get the fixed payment (coupon) or not. For example, in 2024, Liberty issued a digital on a portfolio of the S&P500 and Eurostoxx 50, which will pay a predefined 7.15% a year as long as the indices are flat or positive, and the capital back if neither index has fallen by more than 30%.
Auto calls have different capital protection barriers at different levels and are typically provided to sophisticated investors who have experience investing in structured products.
Institutions use them for shorter-dated periods.
If an investor is looking for an income and wants more than the bond market can offer, taking a bit more risk and linking the return to equities in a coupon-type product like a digital or an auto call can provide a predefined ideal outcome relative to a reference asset as long as the market is positive or stable.
This is always riskier than just investing in a normal bond, so the investor needs to be compensated for the additional level of risk.
Equity- or credit-linked notes
Structured products may also be classified as equity-linked notes or credit-linked notes.
An equity-linked note (ELN) has a pay-off linked to an equity index or basket of shares.
Credit-linked structured notes are linked to bonds.
A typical five-year guaranteed outcome investment could be a structured note issued by a large offshore bank with a link to South African government bonds.
The outcome is linked to the South African government bond, so if the South African government defaults on the bond, then the product defaults. This adds another layer of credit risk to the product.
Investors and their advisors need to be comfortable with the issuer and the guarantor.
