Introduction:
Structured products are financial instruments that offer investors a unique way to access various asset classes, tailor their investments to market views, and achieve specific financial objectives. However, investing in structured products requires a clear understanding of their features, risks, and suitability for individual investors. In this article, we explore structured products in detail.
Client Suitability and Responsibility: Determining the suitability of structured products for individual clients is the responsibility of wealth managers rather than the manufacturer or issuer. The manufacturer and distributor must ensure the product is suitable for some investors based on a “reasonable basis” but not necessarily for a specific investor. Recent regulatory reports highlight the importance of educating investors and providing clear information about complex financial products.
Factors to Consider: When evaluating structured products, investors should consider several key factors:
- Fees and Other Disclosures: Structured products typically carry fees ranging from 1% to 6% or more. These fees include sales credits or commissions paid to financial advisors and compensation to the investment bank structuring the transaction. Additional marketing costs may apply.
- Tax Implications: It’s essential to consider the tax impact of structured products, especially for buy-and-hold investments. Investors should assess their expected tax position at the security’s maturity.
- Liquidity: Understanding the liquidity and availability of a secondary market for structured products is crucial. Some structured products may lack liquidity, making them suitable for long-term investors.
- Credit Ratings: While default risk primarily rests with the investment bank manufacturing the product, investors should also consider the creditworthiness of the product distributor. The distributor plays a significant role in marketing support, application processing, and ongoing administration.
Structured Products in an Investor’s Portfolio: Structured products have evolved from being considered niche investments to core holdings in many investors’ portfolios. They are particularly attractive to conservative investors seeking to reduce portfolio volatility. For example, structured products with underlying assets like equity indices can offer both upside potential and risk control. These investments provide a balanced approach to reducing market risk, especially for those approaching retirement.
Understanding Structured Product Terms: Structured products come with various terms and features, including:
- American and European Options: These define when options can be exercised.
- Barrier Level: A pre-specified level for the underlying asset that triggers a change in potential product return.
- Basket Option: An option based on the performance of multiple indices or shares.
- Cap: Some structured products specify a maximum return, which is referred to as a cap.
- Capital Protection: Certain structured products ensure a minimum return at maturity equal to the initial investment.
- Credit Rating: The credit rating of the product issuer may differ from the rating of the structured product itself.
- Derivatives: Structured products often use derivatives to generate returns based on underlying assets.
- Soft and Hard Protection: Soft protection involves a level of capital protection, while hard protection guarantees full capital protection.
- Rainbow: A return based on the performance of a basket of assets, with weightings given to better-performing assets.
- Secondary Market: Many structured products are not designed for secondary trading due to their unique nature.
- Wrapper: Structured products are sold through various wrappers, such as ISAs, deposits, and life bonds.
- Zero Coupon Bond: A bond that pays no periodic interest, instead growing to a predetermined maturity value.
Goldman Sachs Capps: The Goldman Sachs Capps (Capital Preservation Portfolio System) is a portfolio management scheme that aims to provide defined downside risk and unlimited upside potential through options replication and dynamic hedging based on the Constant Proportion Portfolio Insurance (CPPI) model. This model adapts allocation between equity and cash based on underlying asset performance.
Risks Associated with Capps: Investors in the Goldman Sachs Capps should be aware of certain risks, including:
- The level of preservation is not guaranteed.
- Actual NAV may be lower than the defined floor in certain situations.
- Upside participation may be less than 100%.
- The NAV may not rebound proportionally with the market after a severe correction, leading to limited upside participation.
- If the floor is reached, the portfolio becomes 100% cash.
Conclusion: Structured products offer a diverse range of opportunities for investors but come with specific terms, features, and risks. They can be a valuable addition to an investor’s portfolio when understood and utilized appropriately. Working closely with a financial advisor is essential to ensure structured products align with individual financial goals and risk tolerance.
Investors should carefully assess their suitability, risks, and the unique terms associated with structured products to make informed investment decisions.