Understanding structured investment products

Why structured products?

Structured products have a predetermined payoff profile that is set at the start of the investment. Unlike a traditional unit trust investment, they therefore offer a degree of predictability and in many cases, capital protection. While less liquid than traditional investments, structured products can still offer limited liquidity for emergencies. Their full potential is realised when held to the end of their term. Underlying instruments are typically equity indices, which are often uniquely thematic and not easily accessible to retail investors.

Is capital protection a key feature of structured products?

One of the main features of structured products is capital protection. Most of these products offer some form of protection of the initial investment amount. Such a safety net makes structured products appealing to investors who wish to participate in market growth without risking big capital losses. Because of the protection and the complexity of the underlying instruments, structured products require a medium-term commitment – usually three to five years.

How are structured products issued?

Structured notes are usually issued by banks. Life insurance companies offer structured products via an investment policy that provides the required payoff profile. While investors can hold structured notes directly in a stockbroking account, they are often offered through a wrapper such as an endowment or sinking fund policy, which may offer tax advantages.

What are the predictable outcomes?

The second defining feature of structured products is the defined payoff. There are three main payoff types. Growth products (participation notes) provide geared participation in positive index performance – for example, two or three times the index’s return, with capital protection if the index’s performance was negative.

Defined benefit or digital coupon products offer a fixed return if the underlying index is positive at maturity, regardless of how much it has increased by. For example, if the product promises a defined benefit of 80%, the investor receives 100% of their capital plus 80% in a single lump sum payment if the index ends higher. If the index performs negatively, only the initial capital is returned. Auto calls pay a predetermined coupon if certain conditions are met at scheduled observation dates.

If the index is above its starting level at the first date, the product “auto-calls” which means it matures automatically and the investor receives their capital plus cumulative coupons. If the condition isn’t met, the product continues to the next observation date until maturity, when capital is repaid if the index remains below its starting level.

What are the diversification benefits?

One of the greatest benefits of structured products is that they can enhance portfolio diversification. Their return profiles are typically uncorrelated with traditional asset classes, making them valuable additions to a diversified investment strategy.

What are the risks and considerations?

As is the case with any investment solution, structured products have a downside. The main drawback of structured products is their reduced liquidity. Because they are designed to be held for the full term, early redemptions may not deliver the expected payoff. They also carry credit risk – since they are issued by banks, investors are exposed to the issuing bank’s ability to meet its obligations. However, these institutions are generally high-quality, investment-grade entities.

Structured products are best suited to investors with a medium- to long-term investment horizon who do not require frequent access to their funds. For younger investors, allocating a portion of a long-term portfolio to structured products and reinvesting that portion in another structured product at maturity can be an effective strategy.