Do you know what I mean by ‘structured products’?
If someone mentions structured products, probably the last thing that comes to your mind is a financial instrument. Instead, perhaps you imagine material for some engineering works. Well, almost. These products do relate to engineering, but financial engineering.
To give you an encyclopaedia definition, we would say that a structured product is the union of two or more financial products in a single structure (stocks, interest rates, financial derivatives, etc.).
This type of product remains one of the great unknowns for the majority of investors, although in recent years financial institutions have been working to raise awareness of them as a further product that may be accessed, striving to make them as understandable as possible.
The fact that they can be configured in multiple combinations means that can be custom-designed and they offer a wide range of options. To make things simpler, let’s imagine a cocktail shaker to which we add ingredients until we create the perfect cocktail for the customer on the other side of the bar. Every cocktail will be different. Made according to every customer’s personal characteristics and suited to their individual strategies.
Before taking an interest in a structured product, as with any other financial product, we must weigh up the risks and benefits of this type of investment product.
Considering the first criterion we mentioned, being able to create tailored products makes it possible to offer the option of diversifying investments. In other words, not putting all our eggs in one basket. Another important aspect is that this category has the potential to offer more attractive returns than traditional assets such as equities or fixed income.
That said, it is also important to be aware that structured products are complex and tend to have little liquidity when it comes to selling the product before maturity. As a result, we must have a very good understanding of the product.
Looking at the types of structured products that exist, we first come across capital-protected products. We can say that this type is the most straightforward because, as the name suggests, the capital is protected by a third party (the issuer of the product). For this reason, while it may look similar to a deposit, we must take into account the risk of the product issuer.
In the middle ground, we could include credit-linked notes, in which, in exchange for a higher remuneration, the credit risk of a third party is assumed within the structured product. This higher remuneration will be in line with two main components, namely the interest rate and the credit risk of the underlying entity. This means that the worse the rating, the higher the remuneration we will demand.
And at the other end of the spectrum, within what we can consider to be more complex products, we have autocallable products, in which the capital is not guaranteed and, therefore, may be lost at maturity. These products may be called over the course of their life, depending on the performance of the underlying assets (stocks, commodities, etc.) in exchange for a higher remuneration.
Let’s break things down with an example that I hope will make things clearer. Imagine we have a product in which we invest 100 euros for 1 year in exchange for a 3% coupon. If, at maturity, the issuer of the product has not experienced a credit event, the customer will receive the repayment of the investment plus the agreed coupon. It would be very similar to a traditional bank deposit, but with the added risk of the product issuer.
This type of instrument might appear too complex and difficult to understand. In some ways it is, and that is why it is important to ask for support from the experts as we would with engineering works. In this case, we need to consult financial advisers so they can tell us everything we need to know about this type of investment product.
Published in Diari d’Andorra (23.08.2023)