Do sophisticated structured products have a place in the average investors portfolio?

[Rock Private Office]

Some would argue that adding structured products into a portfolio creates unnecessary levels of counter-party risk and for that reason alone should be avoided.

However, spreading exposure across different products from a selection of counter-parties is key to successful portfolio diversification, and Structured Products can be a useful overlay, either to enhance returns or limit downside risk.

So how exactly can they help?

Returns are based on the performance of a reference asset, commonly referred to as the ‘underlying’, which can be anything from a commodity, stock index, an interest rate, or even an inflation rate. This allows exposure to markets that might be difficult for retail investors to access directly. By diversifying exposure across a range of different (and often uncorrelated) markets, investors open up more opportunities to generate returns and hedge losses.

One of the main benefits of structured products is the fact that they provide defined returns upon maturity. This can help investors to achieve particular planning objectives: not only can they use structured products with different maturities to help manage the duration of their portfolios, but products that pay fixed returns under certain market conditions can help them achieve greater stability of returns.

Structured products can have an important role to play in modern portfolio management, providing yield enhancement in low-risk or cash-rich portfolios or offering protection to more adventurous, growth oriented portfolios, optimising the risk reward balance in even the average retail investor's portfolio.

[de Heydon]

Pete,

I am ignorant as to exactly what 'structured products' are.

Do you have any examples of 'structured products' that you frequently use ?

[Rock Private Office]

Pete,

I am ignorant as to exactly what 'structured products' are.

Do you have any examples of 'structured products' that you frequently use ?

You can think of Structured Products as contracts. Typically between private investors and a bank (the counter-party risk mentioned above).

The return is based on a formula, applied to underlying market linked investments. The underlying could be any of a broad range of assets, typically global indices (e.g. the FTSE 100 or S&P 500), commodity prices, currencies, or the performance of a basket of individual themed stocks, say for example six bank or hi tek stocks. The bank pools all the monies received from the sold contracts and and makes the investment that will provide for the contractual returns.

They often offer capital protection and a fixed return. For example a product based on an index like the S&P may be a 5 year contract that offers 2% per quarter providing the index is higher or has not fallen below 95% of it's original value on each valuation day. If the index is below 95% of the original value on valuation day - no pay out. On the final day of the contract 100% capital is returned providing the S&P has not fallen below a specified barrier - for example 40%. If however for example the index had fallen below by 42% the original capital returned to you would be 58%.

The underlying investments and formulas applied to structured products can vary wildly. The one described above could for example offer 100% capital protection but obviously the pay off for this would be smaller returns. Or you could have less capital protection and higher returns.

It is also possible to create bespoke products. You can specify the underlying investments required and agree the formula to be applied with the bank. This can usually be arranged from $1m USD although the contract can be subscribed by several investors.

I guess you can see how these can be used in a portfolio to add a level of predictability? You know when the capital will be returned, you often have a fixed return even if the underlying investment has fallen in value etc. I prefer them to cash deposits provided liquidity is not an issue - although contracts vary in length from as little as 1 year. The downside in the example I described, would be that the S&P could have a Bull run, but you still only receive the contractual return of the Structured Product. Also if the underlying goes below the capital protection barrier, you loose just the same as if you had been invested directly, but cashed in at the worst possible moment!

I hope this makes sense? It's a little off the cuff, I'll try and write something a little more in depth and add it here during the week.

But it is said that if an investment can't be explained succinctly in a few sentences you should walk away!

[de Heydon]

But it is said that if an investment can't be explained succinctly in a few sentences you should walk away!

This stuff is way too complex for a simple-minded, country boy, I'm walking.

[Rock Private Office]

But it is said that if an investment can't be explained succinctly in a few sentences you should walk away!

This stuff is way too complex for a simple-minded, country boy, I'm walking.

haha! You are a wise investor!  

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