Be careful before investing in a complex financial product
Mar 21, 2012

Author: PersonalFN Content & Research Team

When investor sentiments are positive and the overall investment environment is vibrant, the manufacturers of financial products try to make hay when the sun shines. Well, they make most of such times; launch several news schemes, thus attempting to lure investors. Moreover, today financial innovation is occurring at such a rampant pace, that simplicity is lost and products are getting rather complex. Thanks to the financial engineers and marketers of such products.

The questions which keeps lingering is that, is such financial innovation indeed creating unique products and do instil creating prudent asset management practices, or it is just there to woo investors and gather more money. Interestingly, today there has been so much of acceleration towards financial innovation, that even distributors / agents / relationship manager (i.e. the important financial intermediaries too are finding it tough to understand these products, and in case they have been successful in selling such a complicated financial product, investors are left in a tizzy.

At present, too we are in no different environment. While Euro zone debt worries still remain, the environment in India is rather exuberant, because Foreign Institutional Investors (FII) have turned their heads towards Emerging Market Economies (EMEs) such as India, as our country exhibits to offer far better economic growth than in the developed countries. And thanks to the easy money policy adopted in developed nations for this as well, which is bringing in more FII participation.

Citing this opportunity some of the well-known financial institutions have come up with fancy investment products to grab investors’ attention. Some of the issuers have started launching new principal-protected structured products, as processes to comply with new valuation norms are put in place (by the Securities and Exchange Board of India (SEBI)) and appetite for equity investments too has improved among wealthy investors.

Last year in September 2011, SEBI had made it mandatory for issuers of principal-protected structured products to appoint a third-party valuation agency, which needs to be a credit rating agency registered with the regulator. According to the guidelines, valuation of structured products would be put up once a week on the websites of the issuer and the rating agency. Issuers are also expected to provide the value to investors on request free of cost. Moreover, the cost incurred for valuation shall be disclosed in the offer document of the structured product. Also, the guidelines made it clear that the securities which do not promise the return of principal amount in full (i.e. capital protection) on maturity would not be considered a debt instrument and cannot be issued and listed.

Things to be kept in mind by the investors before investing…
While most manufacturers of such products, did mend their offer for structured products which now provide capital guarantee (i.e. protection of principal amount) as directed by the SEBI;, as investors it is important to keep in mind the following and make it as a checklist before making any investments:

First and foremost, check whether the issuer is a SEBI registered entity
Check the offer document for the following:
- Scenario analysis of the security’s value under rising, stable and falling market conditions
- Risks regarding mathematical models used to create the security and credit risk of the issuer
- Commissions being paid to distributors and also the conditions for premature redemption
- Information on valuation of the product, and guidance on exit loads, exit options
- Information on liquidity of the security issued (this will help you to exit the product at any time)

Our view:

We think that directives issued by SEBI, for principal-protected structured products would go a long way in protecting investors while they get wooed by such products (and even rampant financial innovation). Moreover, since the minimum net worth for the issuer has been set at Rs 100 crore by the capital market regulator, the entry criteria has been a made stern. Also, since the minimum investment amount for a structure product has been increased to Rs 10 lakh, investors with a higher risk appetite only will be able to access these structured products.

Despite the principal amount guarantee given by these products, we are of the view that investors should act responsibly and undertake checks and balances before investing their hard earned money in such fancy products.

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