Structured products are pre-packaged financial products designed to facilitate customized risk return objectives. They are based on a traditional security with modified payment features linked to the performance of an underlying asset. There is no strict formula for the composition of structured products but they are generally based on derivatives, baskets of securities, options, swaps, commodities, or indices. Because of the highly customizable nature of these products, examining a few examples of is the best way to acquire a basic understanding of them.
Many structured products perform a principal guarantee function in the form of what is essentially an accrual bond. An accrual bond, sometimes called a “zero-coupon bond,” is a security that does not pay interest payments but is purchased at a discount and redeemed for its face value at maturity. In addition to this principal guarantee, a structured product will have a second component contingent upon the performance of an underlying equity instrument. For instance, the second component in this example could be a call option on an equity index that pays a predetermined amount for gains above a predetermined level.
As a second example, let us look at a structured product recently featured on the AVC advisory website. This structured product offers a quarterly coupon payment of 2.1% for a period of five years. This 8.4% potential yearly yield is contingent upon the performance of three developed world stock indices. So long as the three indices do not fall more than 40% from their initial value at the end of the previous quarter investors will earn the quarterly interest payment. Unlike the prior example, there is risk of principal loss with this product if any equity index is lower than 60% of the strike level at the time of the notes’ maturity.
These two examples are examples of growth products and income products respectively. Growth products provide a level of capital protection whereas income products provide a higher income with a risk to the capital return. Generally, principal protection features are traded for a variety of performance features. Different types of structured products give the investor flexibility and allow him or her to invest in accordance with his or her personal expectations.
Despite their recent surge in popularity, structured products are occasionally criticized for their illiquidity. The highly customized nature of the investment makes them a buy-and-hold asset. Some innovations have been explored such as exchange-traded-notes, a product made to resemble an ETF composed of debt instruments with returns contingent upon the performance of an underlying asset. The customized nature of the structured product also makes for pricing, rating, and regulation difficulty. Investors should work closely with their financial advisor in order to perform the extra level of due diligence recommended before investing in a structured product.
One of AVC Advisory’s core financial instruments is the structured product. Our experienced team members are more than happy to work with investors interested in finding a structured product that is right for them.