Structured Products

Structured Products can form an important part of a diversified investment portfolio. Clifton Wealth offer advice and insight into these products and the team are constantly conducting research into the performance of the many providers of these products.

How they work

Structured products are investments with a pre-set formula for calculating returns and a pre-set formula for calculating risk. The investment is ‘built’ or ‘structured’ so that the buyer knows exactly the underlying asset or market their investment returns are linked to and how the ‘upside’ gains and ‘downside’ risks will be calculated.

Structured products originated in the wholesale finance area including an array of complex products including collateralised debt obligations (CDOs) where returns to holders were linked to payoffs from portfolios constructed of a variety of asset-backed securities. In contrast, retail structured products were initially devised by the private banking / wealth management industry to offer wealthy clients full or partial capital protection on their investments with returns linked to an underlying asset.

An example would be a capital protected investment with returns linked to the performance of the FTSE 100 index over, say, a five year period. The clients’ capital would be guaranteed over the investment period and the payoff would be linked to the performance of the index over the five-year period. If the returns were based on an increase in the FTSE index, the payoff would relate to the increase in value of the index over the specified time frame.

Example

Retail structured products can come in many forms. The most common provides capital protection and returns based on an underlying index – this could be a standard market index like the FTSE or Dow Jones or more exotic indexes covering commodity prices. There are combinations of indexes from ‘hot’ markets – like Brazil, Russia, India and China – or ‘hot’ asset classes such as oil, gold, soft commodities and so on.

Some may have returns based on exchange rate bands – you get a pay off if exchange rates vary within a range, but no return if the rates move outside the band – or interbank rates. Typically the wealth management industry structures these products based on investor demand. The more exotic and complex the payoff then the more complicated the structuring as the underlying return to the investor is based on a variety of derivative investments. Higher risk structure products tend to have lower capital protection, say 70 per cent, with bigger potential returns.

Investors in such products need to be aware of the fact that the more complex the payoff the more they will be paying to the seller for the structuring even though payment will be implicit and bundled in the price.

If the underlying asset does not generate a return over the period of the investment then the investor has forgone returns that could have been earned by investing in a traditional capital protected investment such as a bond or bank deposit. Also, there may be substantial costs associated with cashing in the investment before it matures. On the other hand such products enable investors to have capital protection and payoffs related to a wide variety of underlying assets.