The role of structured products in an uncertain world

Structured products have become increasingly popular in an increasingly volatile and uncertain world where investors want to preserve their capital, but also want decent returns, that track or beat inflation.

They also want transparency, particularly around costs, tax and potential returns.

Corporate and Institutional Banking, a division of Investec Bank, explains what structured products involve.

Many structured products provide capital protection and geared returns in an uncertain economic climate. However, with an array of offerings out there and each one with its own features, it's often difficult to discern whether an offering is right for a particular investor's needs.

Armed with some key basic knowledge, investors should be able to choose an investment that suits their needs.

Each structured product is different, but most share the following features, which could influence one's decision:

Capital protection

Capital protection is probably the best-known feature of structured products.

A typical structured product (usually with a maturity of between three and five years), may have 100% capital protection, ranging from 100% or perhaps a certain percentage (say 20% or 30%).

Geared returns

This simply means that investors earn a multiple of the return of the underlying index or group of indices. The underlying returns are often capped at a certain level, but investors will still earn the multiple up to that level at which the underlying return is capped.

Such gearing is thus useful for investors who are only mildly bullish about the underlying index. Important to note that the geared returns are linked to a price only index and the investor forfeits their dividends by not investing in the index directly.

Returns can be in rand or foreign currency

It's important to look at the currency to which the investment is linked. Structured products will often link returns to a well-known stock market index, such as the S&P 500, FTSE 100 or Nikkei.

Others will be linked to a group of indices. But some will offer the return in US dollars, euros or Sterling, while for others, the returns will be in rand.

In addition, investors should consider a few important questions:

How does the structured product fit into one's overall portfolio strategy?

Structured products can be a useful tool for diversification, thanks to their capital protection and geared return features as well as their focus on specific markets.

Investors need to look at how these fit into their overall investment strategy.

Is the investment optimal from a tax and retirement structure point of view?

The three- to five-year term of a typical structured products addresses this, but increasingly investors want investments that are suitable for a retirement vehicle, such as a retirement annuity or living annuity.

These investments can be structured to comply with the guidelines of the Pension Fund Act. Regulation 28 of the act is designed to protect investors by setting guidelines for allocating to certain asset classes, including offshore.

What are the risks?

Structured products are generally low-risk investments but are not risk free. Investors should for example be cognisant of credit risk.

A structured investment is essentially a contract between the investor and the issuing bank, with the latter promising to deliver the returns described above.

Another issue to be aware of is liquidity. Most structured products are designed to run over three to five years, so ideally investors should preferably invest money that they’re prepared to put away over that length of time.

Structured products often offer the investors an active market to unwind early.

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