They are Complicated, Investors Should Understand the Risks
During stock market volatility, it is not surprising to find even investors with comprehensive knowledge of the markets redeeming their investments before the predefined time. Considering the losses suffered from equities, investors have started looking at other investment opportunities. Structured products are customised to an individual's needs and comprise various financial instruments, like derivatives, stocks, bonds and debentures, with different investment strategies in a single portfolio — or a prepackaged strategy in which value is derived from the performance of various underlying assets, such as equity indices, stocks, commodities, interest rates, etc.
These products were initially made available to cater to the needs of high net worth investors. However, they are now being offered to retail investors as well. To that end, the concept of structured products is relatively new for retail investors. The benefit of investing in these products would be that a sophisticated investor can theoretically take direct exposure to derivatives. However, the size required for direct access is not possible in most of the cases.
A feature of some structured products is a "principal guarantee" function, which offers protection of principal if held to maturity. In a non-capital protected structured product, the principal amount is not guaranteed. This exposes an investor to the risk of losing his capital. If we compare capital guaranteed structured products with FDs, mutual funds, and direct equities, the degree of principal protection is higher in structured products and FDs but liquidity is very low. Structured products have the potential of giving higher returns on maturity.
To illustrate the concept of capital protection structured product consider this: an investor invests . 100; the issuer simply invests in a risk-free bond that has sufficient interest to grow to . 100 after the five-year period. This bond might cost . 80 today and after five years it will grow to . 100. With the leftover funds, the issuer purchases shares or derivatives as per the investment strategy.
Structured equity products allow investors to achieve higher returns on their investments by expressing a view and accepting certain risks. However, these products do not talk about the credit risk involved in the debt component. Some of the structured products claim to perform across market conditions. These products are designed in such a manner that if the fund manager doesn't utilise, the entire funds or the fund can have a higher cash component. Subsequently, this will hurt the fund's performance in the longer duration.
These days, investment banks more frequently offer structured products to retail investors through their broking networks. But when it comes to investor protection, the question is whether retail investors adequately understand the complicated structure of these products, which often include embedded options, and the implicit fees being charged for these products. The inherent illiquidity or premature redemption of most structured products, including even listed ones, heightens these concerns.
There are major concerns about such product. The Securities and Exchange Board of India (Sebi) has asked credit-rating agencies not to rate non-capital protected structured products. Without rating, it has become difficult for issuers to sell these products to investors. Structured products are not as simple as they seem to be. Since they use a blend of investment strategies, it is difficult for most investors to understand the strategy driving the fund. Understandably, investors aren't aware of the situations when the strategy might fail to deliver.
Structured products were in big demand from HNIs early in 2008. But after the collapse of the US investment bank, Lehman Brothers, investors have started doubting the ability of issuers to return the principal. That's why they started searching for simpler and more transparent options. This virtually shut the market for structured products. But renewed interest in these pre-packaged products now indicates a return of confidence in issuers.
Issuers also need to work towards making these product more lucrative and acceptable among investors. They can, for example, invests in options with longer tenor, design products by assessing the suitability of the investors, and make proper disclosure of risk to the investors. A change in regulations can also help protect investors' interest.
