A structured product is a result of financial innovation that offers an investment solution that can be structured as per your risk-return profile. Most of the wealth managers often come up with structured products for their high net worth (HNI) clients.
- What are Structured Products?
- What are the Components of Structured Products?
- How does a Structured Product Work?
- What are the Key Features of Structured Products
- Structured Products Market in India
- What are the Benefits of Investing in Structured Products?
- What are the Various Types of Structured Products?
- What are the Important Points to Keep in Mind While investing in Structured Products?
What are Structured Products?
Structured products are market-linked investment solutions that are hybrid in nature and are tailor-made to adapt to your unique needs such as risk-return objectives and liquidity requirements.
Basically, the investment strategy of a structured product is non-traditional in nature that combines two or more asset classes (conventional assets combined with derivative products) to meet your specific needs.
This integrated investment solution is highly customisable and can offer you efficient diversification to your investment portfolio.
The performance of structured products is often linked to the performance of the NIFTY index.
A typical structured product comprises bonds, equities and derivatives as an underlying asset class.
These products can either come with capital protection (full or partial return of principal) feature or without a capital protection feature.
The objective is to enhance your investment return by investing in market-linked instruments such as bonds and equities while balancing out the risk during a market downturn by investing in complementary instruments like derivatives.
What are the Components of Structured Products?
Structured products with debt securities/bonds and equity derivative exposures are quite popular in India.
Typically, the following are the components of structured products in India:
- A bond: Capital protection is offered by the bond component as the issuer of the bond promises to return the principal. In the case of structured products without capital protection, you can expect additional income and stability.
- Equities (one or more): Equities as underlying assets enhance the return potential of the investment. There would be a single equity instrument or basket of securities such as stocks along with ETFs that follow a popular index, foreign currencies, etc.
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- A derivative product: The derivative component helps to balance out the overall risk. Options are commonly included as a derivative component in a structured product depending on the risk-tolerance level.
How does a Structured Product Work?
Though structured product majorly comprises traditional assets like bonds, it is strategized in a way to replace the usual returns of the bonds with non-traditional payoffs from other underlying assets, such as derivative products.
Let’s understand the working of a structured product with a simple example. Let’s assume, you invest Rs. 1,000 in a structured product with capital protection feature for five years.
That means you would receive the initial investment on maturity (on completion of a five years period) along with the return linked to the performance of an underlying asset over the period of five years. In this case, Rs.800 out of your Rs. 1,000 is invested in bonds or debt instruments whose value reaches up to Rs. 1,000 at the end of maturity, i.e. five years.
This is because the fund manager would invest in fixed coupon debentures to preserve your capital.
Now, the remaining Rs. 200 would be invested in equities and derivatives to generate the return and income.
The final return would depend on the performance of the particular index that the securities follow.
If the performance of the index is positive, say 25% over the last five years, then you would receive total return along with the amount invested (capital) on maturity.
In case, the performance of the index falls below the level at which investment was made, you would only receive the amount invested (capital) on maturity.
What are the Key Features of Structured Products?
Structured products are issued by the private banking teams, wealth management firms and non-banking financial companies (NBFCs).
The top issuers in India include Edelweiss Capital Limited and Kotak Securities Ltd. including some of the foreign players like Merrill Lynch and Co. Inc and Citigroup Inc.
Following are the features of structured products –
- Asset composition: Structured products are hybrid investment products with a complex composition of assets.Basically, structured products consist of fixed income securities like bonds as a large component for capital preservation along with equities and derivative products as an underlying asset class for capital growth and income.
The right composition of asset classes allows the structured products to maximise the probability of return with efficient management of risk.
- Investment amount: The ticket size for the investment into structured products may vary across issuers.In India, structured products are generally designed for high net worth investors (HNIs) starting with the minimum ticket size of Rs. 25 lakhs.
Most of these investments are done through PMS (portfolio management services) and the guidelines of PMS are followed for the minimum cap on investment amount also.
- Risk-return profile: Risk-return profile of the structured product may vary totally depending on the way in which the particular product is structured.Being a highly customisable investment product, structured products can be modelled to suit the needs of conservative to highly aggressive investors.
As the return of this product is linked to the performance of an index, the return generated generally ranges from CAGR (Compound annual growth rate) of 10% to 25% or even higher depending on the composition, market conditions and various other factors.
Apart from the market risk, structured products are also subjected to the credit risk of the issuer as a bond being the major component.
- Tenure: Generally, structured products come with limited maturity which requires you as an investor to stay invested for the specific period.In India, the maturity of structured products ranges from 12 months to 36 months as these products are structured around the equity market.
- Professional management: Structured products are designed and managed professionally to meet the risk-return objectives of the investors.With professional management, structured products are effectively managed with various strategies to meet the return requirement.
The structured product offers flexibility to meet the requirement even during the market downturn.
The fees for the professional management of structured products may vary across issuers.
Structured Products Market in India
In India, structured products started garnering the limelight sometimes during 2007 and 2008.
Structured products are also referred to as market-linked debentures (MLDs).
According to CARE Ratings, the structured product segment or market-linked debentures in India will increase in size by the issuance of up to Rs. 17,000 Cr. in FY 2020 in comparison to Rs. 12,246 Cr in FY 2019.
You can take a look at the report issued by CARE ratings on this.
What are the Benefits of Investing in Structured Products?
Considering the market volatility in recent years, structured products are gaining popularity. You can benefit from the market upside by investing in structured products while limiting your risk during the economic downturn.
Mainly, the following are the benefits of investing in structured products
- Customised view: As structured products are highly customisable, it enables you as an investor to have a view on the market for two to three years specifically and then monetize the same.
- Capital protection: Most of the structured products come with capital protection features that make it a suitable choice for risk-averse investors. However, all types of investors can invest in structured products to benefit the diversification it offers.
- Higher return potential: Along with capital protection, structured products can generate attractive returns depending on the performance of the index the underlying asset is linked to.
- Risk return dynamics: Structure product boosts the portfolio return by investing in growth assets and manages risk efficiently by investing in derivatives.
- Hybrid exposure:Exposure to two or more asset classes and mix of traditional and non-traditional assets offer efficient diversification to your investment portfolio.
- Tax efficiency in Structured Products: Structured products are gazing the focus of high net worth investors (HNIs) and institutional investors due to its tax efficiency.When it comes to the tax treatment of structured products, long-term capital gains are taxed at 10% (for the investments held for more than 36 months) + surcharge for listed market linked debentures (MLDs).However, considering the complexity of the structured products, it is important to consult tax experts and seek advice before you invest in any structured product.
What are the Various Types of Structured Products
In India, structured products are mainly categorised in two types based on their benefits offerings and the way they are modelled.
- Conservative structured products: Conservative structured products are the investment solutions that come with capital protection themes. The upside participation of these products in the risk asset returns is relatively lower.
Let’s take an example to understand this. Let’s assume you have invested in a conservative structured product with 140% upside participation in equity markets till maturity.
That means, on maturity if the market falls below the index level at which it was invested, you get back your principal.
Here, 140% upside participation means, if the index or benchmark increases 10%, then you would receive a 14% return on the equities/derivatives portion of your investment.
- Aggressive structured products: Aggressive structured products are the investment solutions that come without capital protection features. The upside participation of these products in the risk asset returns is relatively higher.
Let’s take an example to understand this. Let’s assume you have invested in an aggressive structured product with 200% upside participation in equity markets till maturity.
That means, on maturity if the index fails to cross the level, you may lose out on a part of your capital also. But, there is potential for higher returns also depending on the performance of the index.
What are the Important Points to Keep in Mind While investing in Structured Products?
If you are considering investing in structured products for diversification or for higher returns along with the preservation of capital, here are a few important things for you to keep in mind.
- Liquidity: First important point to keep in mind is the liquidity element in these investment solutions. In comparison to other short-term or medium-term investment options, structured products are not liquid in nature.As structured products pre-packaged investment solutions with limited maturity period, you are required to stay invested in the product till maturity to reap the benefits.
However, some of the markets linked debentures that are listed on an exchange can provide you with intermittent liquidity.
- Suitability to your risk appetite: Specifically when you are investing in a structured product with partial protection of capital or without capital protection features, you need to access your individual risk profile, as there are chances of losing in an aggressive structure.
- Credit risk: Though many structured products come with capital protection themes, the complete return of capital on maturity may still depend on the credit risk of the debenture issuer.
Hence, considering the credit profile of the issuer is also important while investing in a structured product.You need to also access the fixed income portion of the structured product to understand the ratings and to prefer the investments with higher ratings to avoid the credit risk.
Sometimes, a structured product (with capital protection) that comes with a cap on upside participation may limit your gains.
It is important to understand the complex nature of the structured product, the risk associated with each underlying asset needs to be understood before investing in this investment solution.
To sum up, the volatile market has created the need for a financial product that can sustain during all seasons of the market.
An investment solution like structured products that are highly customisable, tax-efficient and also offer attractive returns along with capital protection, are an apt choice for high net worth investors.
Professional design, management and diversification offered by the structured products manage the risk effectively along with enhancing the return.
Structured products can help you achieve your goals with its unique structure and investment strategy in every market situation.