Factors that Affect Returns

Factors that Affect Returns

The returns to an investment is likely the most important aspect we all look at. Structured Products are extremely flexible and each can have several features that affect returns. Once we realize that risk is invariably tied to returns, we can easily understand how the returns (or Coupons) of a Structured Product changes with the design. The more adventurous you are, the greater the potential returns.

Of course a high risk, high return investment is not necessarily a bad one. Neither is an investment with low returns. What is important is that they are each used by investors with the suitable appetite and needs.

Volatility

The volatility of the Underlying Assets is one of the most major factor that affects the pricing of Structured Products. One of the most popular Structured Product type is the Express Certificate a.k.a. Autocallables. This type of design requires the Underlying Assets to stay within a certain range for Coupons to be paid out, early maturity, or full capital protection to kick in. For investors to benefit most, the Underlying Assets should trade sideways to slightly higher.

For Underlying Assets with greater volatility, we would expect them to have a higher chance of performing out of range. As the volatility of the Underlying Assets increases, returns would increase too. Index-based products generally give lower returns than a stock-based one with identical parameters because indexes have lower volatility than the stocks used.

District East Capital believes in helping investors get the most out of their investments. We have invested in ourselves to set up our own database of Underlying Assets and their information, including volatility (colored column in the snapshot above, with other information blurred). By sharing these extra information with the IFA to design their structured product, we hope that they, as well as their investors, will be able to make more informed decisions on their investments.

Outlook

If a Structured Product has Underlying Assets with a great history and performance outlook, we would expect the Structured Product to perform well too. The future performance and outlook of an investment are undeniably subjective things, so let’s illustrate this concept with two arbitrary stocks at the opposite end of the performance spectrum – Stock A and Stock B.

A simple Google search yields a lot of positive news on Stock A, and the company has a lot of development plans for the coming year. The company’s recent financial report shows rising profits and excellent progress in new territories they have expanded to.

As for the company of Stock B, earnings are steadily declining, while the company battles rising operating costs. The management team is also being investigated for fraud, and an increasing amount of compelling evidence is discovered as the investigation progresses.

Stock A clearly has a better outlook than Stock B. In this case, an investment based on Stock A will likely perform better than one based Stock B. The risk on a Structured Product based on Stock A is lower and thus the returns would also follow suit and be lower than a Structured Product based on Stock B. Below is a clearer summary for all of us visual people.

Instead of a single stock, a basket of stocks can be used as the Underlying Assets of a Structured Product too. Especially for Structured Products based on a worst-of basket, having any poorly performing stock in the basket will raise the overall risk. Investors and their advisers should be mindful when picking each and every Underlying Asset that make up the basket.

Product Parameters

If you have made it this far to the article, you would probably be accustomed to the rule of thumb – with more safety, we will expect lower returns. Conversely, returns on an aggressive investment would be higher. Keeping that in mind this neat little table below would summarize this section quite nicely:

There are many different aspects to customize Structured Products and the permutations are not limited to the table above. Generally speaking, the structures all would still follow the mantra of low risk, low returns; high risk, high returns. For any terms that you may not understand, please do not hesitate to consult your financial adviser.

Funding

For people who have been dealing with Structured Products for a while, they probably would have already seen the situation where the exact same product design gives a different price (Coupon) with different issuers. This “phenomenon” is due to funding. Some issuing banks have better funding for Structured Products and thus are able to provide more competitive rates than others. This is why we may sometimes see the majority of Structured Products issued by the same bank – that particular bank simply offers the best prices at that point.

Certain banks have better funding for a specific type of structure as well. For example, Bank ABC provides the most aggressive price for Autocallable structures. Bank XYZ on the other hand, is the most competitive for all capital protected and participation-related structures.

We also see that products with the same design provide different level of returns when we change the currency of the product. Other than exchange rates, funding plays a part too. In current markets, among the three currencies USD, GBP and EUR, USD prices the best, followed by GBP and EUR.

Conclusion

We always try to be as concise as possible but this article may be our longest one yet. We hope that our readers have made it all the way here, and now understand Structured Products a little bit better. Every aspect of our service aligns with our philosophy of ensuring that our clients (and their investors) get the most out of their investment, which our existing clients can attest to.

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 Advisor yet, please do not hesitate to get in touch with us at contact@districteastcapital.com and we would be happy to direct you to an authorized adviser in your region. If you are an adviser and would like a PDF version of this article for a client, please write to us at contact@districteastcapital.com.

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District East Capital (“DEC”) does not provide legal, regulatory, accounting, taxation, financial or any other advice in relation to any investment or series of investments or trading decisions or traded products. All clients, website visitors, and consumers of any of our material are solely responsible for seeking and obtaining their own advice and making their own trading decisions. All, but not limited to, the abovementioned parties shall rely on their own judgment for all trading decisions and investments or series of investments and that will not be in any way acting in reliance on DEC.

 

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