Investing Basics: What are Structured Products?
A structured product is a fixed-term investment whose return depends on the performance of something else, such as a stock market index; this is known as a derivative.
Structured products have become more popular with UK investors as the low interest environment has seen returns on savings and investments remain at rock bottom; they may be the right choice for investors who are unhappy with returns offered by conventional savings accounts, but don’t want to take full stock market risk.
Structured products are ‘complex’ instruments and your broker will require that you sign a disclaimer to confirm that you are aware of the risk associated with trading a product that could return less than your initial investment, however the DIY investor may consider it worth spending a little time getting to grips with structured products as they can combine attractive returns with a high degree of capital protection.
‘Structured products are ‘complex’ instruments’
Unlike many investments, your profit is not always determined by how much the asset rises, but whether it achieves a pre-defined level, which may be higher or lower than when the product was issued.
Structured products are issued for a fixed period of between one and six years, and the product’s payout is not typically provided until the end of the investment term; they can be bought in the primary market when they are first issued or in the secondary market where they are bought and sold on an exchange like shares.
If the conditions for a payout are not met at the end of an investment term, you should get your money back as long as the asset has not fallen by more than a predefined Protection Level – typically 20 – 50% below that starting level. If it has, your capital is at risk based on the fall of the Index
There are two main types of structured product:
- Structured deposits – savings accounts, offered by some banks, building societies and National Savings & Investments, where the rate of interest you get depends on how the stock market index or other measure performs. If the index falls, you may get no interest at all but, unlike structured investments, your original investment is protected.
- Structured investments – typically issued by investment banks where your money typically buys two underlying investments, one to protect your capital and another to deliver a bonus. The level of the return you get depends on how the index or other measure performs. If it performs badly or the firms providing the underlying investments fail, you may lose some or all of your investment.
With structured products the devil really is in the detail because there can be a wide variation in the way different products operate; structured investment providers must provide you with ‘key facts’ information that you can understand, covering:
- what the investment is and how it works
- the key risks including the risk of capital loss and counterparty risks
- charges (fees deducted from your returns or capital)
Structured products are 3D – they deliver defined returns, in defined circumstances, on a defined date.
‘With structured products the devil really is in the detail’
Returns depend on the performance of an underlying asset or index, for example the FTSE 100 index.
Structured products can provide investors with features that cannot be achieved through investments such as shares or bonds; some provide protection against drops in share prices, others deliver returns that increase faster than share prices themselves, yet more can provide positive returns even if share prices do not increase at all.
Product returns are clearly defined in supporting documents and quoted net of all fees and charges which are built into the product.
‘they deliver defined returns, in defined circumstances, on a defined date’
Structured products typically have two underlying investment components:
- A note – a type of debt security that pays interest at a specified rate and interval which is used to provide capital protection and may repay some or all of your original money at maturity; and
- A derivative – a financial instrument linked to the value of something else, such as a stock market index which is used to provide the potential growth element that you could get at maturity.
By combining a note and a derivative the structured product seeks to deliver capital guarantees and a positive return in the form of interest; if certain criteria with regard to the underlying index are met.
Structured products may be a useful addition to a balanced investment portfolio.