Around 10 years ago, structured products found their way into
the portfolio of numerous affluent investors. In the aftermath of the
Lehman Brothers bankruptcy, these products were often portrayed in a
very negative light, even described as too complex and unpredictable.
But are they really that damaging? Or do they offer opportunities for
What is a structured note?
Typically, investment banks or their affiliates develop
pre-packaged investments that provide possible returns in a pre-defined
performance field. The field is determined by two elements — the level
of capital protection so required by the investor, and a derivative
which links the investment with an underlying index, a currency, a
single security or a basket of securities.
For those new to the investment scene, a derivative is a contract
between two or more parties, (like an option, futures contract, or
swap), with the value of the contract determined by fluctuations in the
Complexity: As a candidate investor, it is important to keep in mind
that a structured note is not always a simple debt security like a
government or corporate bond.
Failing to fully understand a structured product causes
disappointment or worse. While a structured note may appear complex,
taking the time to explore and educate yourself will help you in
embedding these instruments as part of your actively managed portfolio.
Structured notes do provide investors with a level of capital
protection, against any significant loss on the invested amount in a
derivative. Be advised, however, that capital protection, although it
sounds attractive, should never be the primary driver to invest in a
product. If you don't want to take any unnecessary risk, it is better to
keep your wealth in cash.
Risks: As an investor you know that the ‘too good to be true'
opportunity doesn't exist. While considering a structured note, you
should review the following risks:
Exposure to credit risk or counter-party risk: This means that
the issuer or the guarantor of the note may not able to meet the
obligation to pay you back at maturity.
As an individual investor, it is not easy to assess the
credibility of an issuer and, therefore, it is advisable to consult some
rating bureaus online. For those who invest frequently in structured
products, it is important not to put all your eggs into one basket. You
should diversify your portfolio not only by asset class but also by
Liquidity: Structured products are not always liquid and rarely
trade once issued. This means invest only with money you can keep aside
till the product matures. Investors looking to sell a structured product
before maturity should also be ready to sell it at a significant
discount. In general it is clear that these products are not made for
speculation on price fluctuations.
Regulations: An August 2009 circular issued by the UAE Central
Bank requires all banks operating in the UAE to take explicit Central
Bank approval for any structured product they wish to offer customers.
The Central Bank took this move to avoid future defaults,
following liquidity issues at UAE and GCC banks after the global
financial crisis. Although the liquidity issues have since been
resolved, make sure your relationship manager provides you with the
Central Bank approved term sheet, before you sign up.
Structured products can add value to your portfolio if they fit
your overall strategy. They are a good value-add for a well-diversified
portfolio if used with complete understanding and awareness about the
underlying mechanism. Given these turbulent times, they can even act as a
protection steer while enhancing returns for an educated investor.