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Understand the concept before investing in structured products


   Also some structured products. That is how most of the conversations with investment experts end these days. Ask them for an ideal portfolio and chances are that you would hear something like a little bit of debt instruments, some equity products and, yes, you guess it, some structured products. No wonder, there are many skeptics who make fun of these products. They claim these products are designed to confuse customers and offer them the false comfort of maximum returns. Point noted, but you don't have to steer clear of these products without even trying to find out what they are all about.


Structured products are customized products that comprise various financial instruments like derivatives, stocks, bonds and debentures with different investment strategies, in one investment basket. Or, simply put, it's a pre-packaged product which invests in various underlying assets such as equity indices, stocks, commodities and interest rates. The performance of the product depends on the returns offered by these products. "Most structured products that are sold in India, have principal protection function as the key element. It simply means the full protection of principal if the investment is held till maturity. Structured products are designed to facilitate highly customized risk return objectives.


   Take a look at the example of a simple Nifty-linked capital protection structure. You are investing, say, Rs 100 in a product with a tenure of 40 months. Of this, Rs 80 is invested in debt securities, yielding a return of 6-7% per annum. Thus, over a period of 40 months, you could get Rs 20 as interest on these debt securities. Hence, this ensures that your capital of Rs 100 is protected. The balance of Rs 20 is invested in the Nifty index. If the Nifty doubles in 40 months, Rs 20 will become Rs 40. Thus the value of your Rs 100 will be Rs 140 at the end of the period, giving you an absolute return of 40%. On the other hand, if the Nifty were to fall by say 50%, then Rs 20 invested would become Rs 10, thereby giving you Rs 110 back. This strategy ensures that at any given time your capital is protected and you will get Rs 100 back at the end of 40 months.


   While this is a simple structure, more complex structures using quantitative strategies could be deployed depending on the risk profile of the investor to generate higher returns.


   Structured products are privately placed and typically offered to high net worth individuals. Structured products are issued in the form of NCDs (Non convertible debentures), whose returns are linked to an underlying stock index such as the Nifty or a basket of stocks. Sophisticated structured products, depending upon the market conditions can be specially created for a set of clients and privately placed. The ticket size generally is Rs 10 lakh upwards. Typically, these products are designed by foreign banks and a few domestic financial institutions. They are distributed by wealth management firms, typically foreign and private sector banks to their high networth clients. One product could differ from the other based on its tenure, participation rate and trigger conditions. With their popularity increasing, they are also available in the form of mutual fund products, mostly as debt schemes in the form of fixed maturity plans (FMPs).


   These products were initially offered to meet the needs of high net worth investors. However, they are now being offered to retail investors as well. The benefit of investing in these products would be that a sophisticated investor can theoretically take direct exposure in derivatives. However, the size required for direct access is not possible in most cases.


   These products were in big demand from HNIs early in 2008. But after the collapse of US investment bank Lehman Brothers, investors started fearing the issuer's ability to return the principal. This has forced banks to search for simpler and more transparent options. The market for structured products was virtually shut for a while. The renewed interest in these pre-packaged products now indicates a return of confidence in the issuers.


   According to experts, most retail investors would find it difficult to grasp the complexity of these products. These days some banks have aggressively started pushing structured products to retail investors through their broking networks. Whether retail investors adequately understand the complicated structure of these products, which often has embedded options and implicit fees, is questionable. Also, the liquidity on premature redemption is cause for worry in most structured products, including even the listed ones.


   Though most structured products offer "principal guarantee" function, which offers protection of principal if held, until maturity, there are also non-capital protected structured products, where 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 FD's, mutual funds, equities, the degree of principal protection is higher in structured products and FDs. However, the liquidity is very low in structured products, though they have the potential of giving higher returns on maturity.


   Structured equity products provide higher returns to investors on their investments by adopting 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 various market conditions. These products are designed in such a way that the fund can have a large cash component. If the fund manager doesn't utilize the entire fund, this will hurt the fund's performance in the longer duration.


   According to experts, the major concern with these products is the lack of rating, which makes it extremely difficult for retail investors to evaluate some structured products. 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 appear. Since these schemes use a blend of investment strategies, it is difficult for most investors to understand the strategy driving the fund.


   That is why most investment experts believe that it would take a while before investors would be ready to park money in structured products. The issuers will have to strive to make it more transparent and easy to understand. On their part, investors need to satisfy themselves that they understand the product very well and it suits their investment and return objective.



Do you need structured products?


>> Just because everyone is speaking about structured products is not a valid reason for you to park your money in them


>> These products are pre-packaged products that invest in a variety of instruments in debt, equity, derivative, currency and so on


>> Though most structured products offer capital protection option, there are products that don't offer protection of capital

 

>> Try to understand the product, the strategy behind it and the risk involved before signing up for it


>> Don't take all the claims at face value, there are chances that some of the strategies may not work all the time


>> Structured products are not the panacea for all your financial troubles. It is okay to say no if you can't comprehend them.

 

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