Part 2: How do Structured Products Work?
Structured products are highly customizable investments (a huge reason why investors like them) that come in all shapes and sizes. There are endless possibilities with structured products but good product designs are as simple as they can get. When financial advisers and investors understand them better, they can customize their investment more accurately to suit their needs.
All of us at District East Capital are always happy to educate and help individuals understand the asset class better; in this article we will explore the common features of structured products!
Performance & Underlying Assets
Structured products have a basket of one or more Underlying Assets, which are usually stocks or indexes. The performance of the basket determines the performance of the structured product. Less adventurous clients approaching retirement for example, would go for an index-based basket of Underlying Assets like the Nikkei 225, and S&P 500. Indexes generlly seen as safer as they are less volatile.
In another example, for a client that looooves anything to do with automobiles, his structured product can have Underlying Assets like Boeing, Rolls Royce, Ferrari – literally a basket of automobile-related stocks.
For most structures, performance is tied to the worst-performing Underlying Asset. The illustration below explain this concept (figures are arbitrary).
The Coupon Trigger determines whether the Coupons (similar to dividends) are paid. Coupons are paid as long as the Worst Performer is above Coupon Trigger. Bear in mind that the Coupon Trigger is fixed and chosen before product launch. With the automobiles example above, let’s fix the Coupon Trigger at 70% and look at a few scenarios with the table below.
A Coupon is paid as long as performance is at or above 70%. The investor gets his Coupons although performance is negative! Profits can still be made despite dips in the economy.
The concept behind the Protection Barrier is exactly the same as that behind the Coupon Trigger above. Instead of looking at Coupons and growth however, the Protection Barrier protects the invested Capital.
At maturity, full Capital is returned to the investor as long as the worst performing Underlying Asset is above Protection Barrier. Structured products are also popular in current markets because of this added safety feature on the Capital.
For example, a 60% Protection Barrier would mean that the Underlying Assets can fall until 60% of “buy-in” price, and full Capital will still be returned at maturity. If it were a traditional investment into a fund, the investor would have lost up to the 40%.
A final, commonly-used feature of structured products is the Autocall feature. To put it simply, Autocall is when the product matures early. Instead of maturity at the end of a 6 year product term, the product can conclude in 2.5 years for example. For most structures, full capital is then returned and final Coupons are paid out when this happens.
Based on the same mechanics as the above, Autocall happens when the product is performing above Autocall Trigger (i.e. all Underlying Assets are above Autocall Trigger).
Understanding the basics are important for investors and financial advisers to think about how they want to customize an investment to suit the investors best. Of course there are other features we can introduce to fine-tune the product to better suit an investor’s profile and preferences. These bonus features will be discussed in another article.
To maximize the versatility of this asset class to suit you best, investors should contact their financial adviser for a recommendation according to their risk appetite and financial goals. If you do not have a financial adviser yet, please do not hesitate to get in touch with us at firstname.lastname@example.org and we would be happy to direct you to an authorized adviser in your region.