Publication: The Business Times, p I 1 Date: 4 July 201 1 Headline:
Structured products - the basics
Structured products - the For those willing to do their homework,
these 'customer-centric products' could in fact be a good option,
reports TEH SHI NlNG
OR the investing newbie, struc- tured products is a term still
taint- ed by the memory of retail inves-
a tors losing hundreds of millions invested in products linked to
the bankrupted Lehman Brothers when the 2008 financial crisis
erupted. Yet, it may be worth ex-
ploring more before you dismiss these as a class of investments
only the sophisticated, well-heeled investor can touch.
For those willing to do their homework and understand each
structured product be- fore investing, these "customer-centric
prod- ucts" could in fact be a good option to add spe- cific
characteristics to a portfolio.
After all, they are designed - "structured" - with specific
objectives in mind and can thus "create value for investors by
offering customised payoffs and risk levels that are dif- ferent
from other basic financial instruments such as normal bonds and
stocks", says Nan- yang Business School associate professor of fi-
nance Low Buen Sin.
Still, "the risks of these products are high and they are riskier
in volatile markets", so the word of caution from Ang Ser-Keng,
sen- ior lecturer of finance at SMU's Lee Kong Chi- an School of
Business, is that "young inves- tors should not undertake such
investments unless they are experienced or if this invest- ment
accounts for a very small part of their portfolio".
With that in mind, let's go over some of the basics and some things
to consider before in- vesting in a structured product.
Structured deposits and structured notes Structured products are
typically fixed-term investments that offer some protection on your
capital.
The term covers a very broad range of "pre-packaged" bundles of
more than one in- vestment, which aim to offer a more custom- ised
return. This typically involves combining a conventional form of
investment with a less conventional one -for instance, creating a
sin- gle instrument out of a bond and an option.
Financial engineering is that process of cre- ating a new product,
usually undertaken by an investment bank. This aims to tailor a
whole range of products with different risks and returns, downside
protection, income, ex- posure and maturity, by combining
underly-
ing assets (shares, bonds, indices commodi- ties) with derivatives
(options, forwards, swaps) whose value depends on the price of the
underlying assets.
In Singapore, the two main classes of struc- tured products offered
to investors are struc- tured deposits and notes. Dual currency in-
vestments, which allow investors to capitalise on narrow exchange
rate movements, are con- sidered a sub-set of structured
notes.
features of structured prod- u c t s a t w w w money- sense gou sg
Those ~nvest- ing In structured depos~ts, however, can be assured
of getting back thelr cap~tal at m a t u r ~ t y , a s long a s the
bank remains solvent
Among the myrlad of structured notes and depos- ~ t s out there,
broad groups Include + Equ~ty or ~ndex-11nked ones hnked to prlce
move- ments of company stocks, Reits, ETFs, market ind~ces +
Commodity-l~nked ones w h ~ c h allocate what's in- vested Into a
buy or sell op- tion on a particular com- modity or basket of com-
m o d ~ t ~ e s + Inflation-linked ones where Interest payments are
linked to the inflation rate wh~le cap~tal is protect- ed *
Currency-hked ones to allow investors to take ad- vantage of
changes in for- elgn exchange rates, but m t h less risk than
direct ex- posure to currencies
Before you invest 1 One of the main pitfalls for
investors new to structured products is that "the risks that they
take are not appar- ent and remote when they first invest in these
prod- ucts", says Mr Ang
Here are a few t i ~ s for ADAM LEE'ST ILLUSTRATION would-be
structured prod-
Generally speaking, banks sell structured uct investors: deposits
to retail investors, while offering 1. Understand all the key
features of the prod- notcs and dual currency investmcnts to more
uct. Be aware of: sophisticated customers, such as their private +
the main themes of the primary product banking clients. and its
derivatives
One key difference between structured + conditions attached to the
minimum as- notes and deposits is that an investor may po- sured
interest rate, if there is one tentially lose his entire principal
sum when in- + formulae used to calculate coupons and the vesting
in structured notes, says the national maturity return,
scrutinising what the worst- financial literacy programme
MoneySENSE's case performance may be guide to structured notes,
which details other + the variable maturity period, and
whether
the bank has the right to call or redeem the structured deposit
before maturity. 2. Think about your future cash flow needs
Structured products are illiquid. You must hold the product to
maturity, which can be as short as two weeks or as long as five
years. Otherwise, you could lose a substantial part of your initial
capital paying what banks call a "premature withdrawal fee". 3.
What capital protection does and does not mean Under a structured
deposit, though not a structured note, you are likely to get what
you invest back. But this depends on the bank stay- ing solvent,
and structured deposits are not covered by deposit insurance.
"Capital protection is not the same as capi- tal guaranteed," says
Prof Low. "We should know that even a simple $100,000 fixed de-
posit is not capital guaranteed. The investor will suffer a capital
loss if the bank goes into bankruptcy. A capital protected
structured product is protected against market risk, not credit
risk."
This means that a structured product that is capital protected can
still be a very high risk instrument if bundled within it are
financial instruments with high credit risk, such as the sub-prime
mortgage loans blamed in 2008. 4. Other risks + Inflation risk:
Even if you get back the prin- cipal sum invested, if the product's
returns do not keep pace with inflation, you may still in- cur a
loss in real terms as inflation erodes the purchasing power of your
capital. + Interest-rate risk: If market interest rates rise while
your capital is locked away in the structured deposit, for
instance, you will for- feit potential gains on the higher interest
rate. So the longer the maturity period, the greater your
interest-rate risk is. + Counter-party risk: A structured product's
underlying derivative arrangements mean that if a third party goes
bust and cannot fulfil its obligation, the structured note for
instance could be unwound, to the investor's loss.
"Structured products can be very complex instruments, some are not
easy to compre- hend, even for very seasoned wealth manag- ers,"
says Prof Low.
So, what has been a constant refrain in this series on basic
investing - "Don't put your money in what you don't understand" -
is especially relevant here, given the potential complexity of
structured products.