Structured Products 101 : How to Invest in the Structured Product

Like any form of investment, going into it head first for the first time is bound to give you the heebie-jeebies a little. However, structured products are somewhat more complex than the average stock or bond investment. You should bear this in mind if you are looking to add structured products to your portfolio. They are designed for more experienced investors, and once you are familiar with some investment basics, you can start considering structured products as a place to invest your money.

What is it?

A structured product is a type of investment that usually has a fixed term (e.g. a 1-year investment) and offers some protection to your money in some cases. A structured product investment will pay a specific level of return on your money invested, subject to various conditions being met.

Remember that capital protection is not provided in all cases, and if the company issuing the structured product goes bankrupt, you risk losing all of your investment.

Structured products are investments where the return is based on the performance of an index, basket of securities or a single asset.  For example, a setup could be as a type of tracker fund that is linked to the performance of a stock market such as the FTSE Straits Times Index (STI). They come in a variety of different names – guaranteed equity bonds; protected investment bonds are some common examples.

The two main types of structured products are

1. structured deposits and
2. structured investments.

How does it work?

Structured Deposits
Structured deposits are deposit accounts. The interest rate depends on base interest rate in the marketplace, and their returns are linked to the performance of some other index, a basket of assets or a single asset. As an example the return may be the performance of the FTSE Straits Times Index (STI) – say 110 per cent of its gain in price – but there is usually a cap on how much return you will receive.

Alternatively, some structured deposits will offer a specified rate of return – for example, 8.1 per cent a year, but this will still be based on the condition that the STI index rises by a particular pre-specified amount.

Structured Investments
Structured investments are in the majority of cases linked to an index performance, although they can also track a pre-specified basket of securities (as set by the issuer of the structured product) or even track just one single asset. In fact, the product’s performance can be linked to nearly any asset class – equity, commodity, foreign exchange, debt market securities and more.  Some structured products offer to protect your initial investment, but not all.

Structured investments have a fixed term for your investment, but some might pay out early if the targets are reached early. There are many different types – some, for example, may offer a fixed annual return provided the STI rises each year,  others promise a fixed return if the index doesn’t fall below a certain level during the term of the investment.  In some cases, returns are paid annually, and for others, returns are paid at the end of the investment term.

How to invest

Although structured products are a sensible choice in some cases, the global financial crisis in 2007-2008 brought to light the fact that some people buying and selling structured products did not properly understand the risks involved. When this is the case you can lose your money, and you should be careful when investing in this product.

You can invest in structured products by buying them from financial institutions that are properly regulated and licensed by the MAS (Monetary Authority of Singapore).  You can buy these products from banks, insurance companies and financial advisers as long as they have the proper licensing to sell structured products.

Remember though that these products can be somewhat complex and you should be careful if you not a sophisticated investor. Key to success with this investment can be choosing the right financial institution to buy it from – with the right adviser you can have all your questions answered clearly so that you fully understand the risks and costs involved in putting in any money. However, the opposite is also true and is something you should always be aware of.

How can it benefit you?

The main advantage of structured products comes to light under specific market conditions – when interest rates are low, stock markets volatile and bonds are expensive. In these conditions, the returns that are available on structured products can be very attractive to investors.

Further to this, there is a broad range of structured products available, and this means you can create a portfolio of structured products to reflect your risk appetite and time constraints on your money. Many structured products offer to protect some if not all of your initial investment which is another plus to this investment choice.  They have been popular in the past for risk-averse investors during volatile stock market conditions.

What to look out for

These products are quite difficult to buy and sell quickly – they are called “illiquid”. This is the case for not all but most structured products but not all. Also keep in mind that not all structured products promise to protect your original investment. Another drawback can be the costs – some can be good value, others very expensive – with charges of 7 percent in some cases.  You have to do your homework and compare what each has to offer as it can vary widely.

Additionally, these products have “counterparty risk” – they are effectively loans to the person who sold you the product, such as the bank or insurance company – this person is called the “counterparty”. This means the risk of your investment is linked to the financial stability of that bank or insurance company.  Research the past performance and track record of both the product and the counterparty before investing in structured products.

Bottom Line

The main thing to bear in mind when investing in structured products is that there is no one universal structure or definition, so you need to keep a close eye on the details before you put your money in.