A few obvious things happen when markets are near their all-time high. Interest of retail investors goes up, small and midcap stocks rise substantially in quick time and mutual funds launch New Fund Offers (NFOs) in a hurry. Initial Public Offers (IPOs) get tremendous response and shares list at huge premiums. There is one more thing that happens when the equity indices are scaling new highs. Brokerage houses, banks and NBFCs roll out structured products for High Net worth Individuals (HNIs). At various platforms, PersonalFN has taken initiative to educate investors and explain to them why they shouldn’t fall for fancy investment choices. In this article, PersonalFN will share with you its views on structured products and possible impact they may have on your portfolio.

What are structured products?

Structure products try to attract investors making claims that, these are the products that allow you to participate in the upside of the market and protect you against unwanted volatility. At present, the most popular structure has been the Index Linked Debentures. They come in two forms, "with capital protection" and "without capital protection". While the former works more as capital protection plans offered by mutual funds, latter work on the assumption that investors would participate in both, profits and losses.

How do they work?

Suppose you are a cautious investor and not comfortable with investing at high valuations such as those prevail at present, you are given a deal by marketer of a structured product. You have to invest Rs 10 lakhs in index linked debentures which will earn you interest at a coupon rate and would also reward you with capital appreciation if the benchmark index crosses a particular level at the end of the tenure of product which is typically say 3 years to 5 years. Usually, the benchmark set for the index is high enough to give a fair chance to both, issuer as well as the buyer. So investor has to take a call whether he expects the index, for example, CNX Nifty to rise more than say 60% in 3 years from these levels. You can make capital gains only if CNX Nifty crosses these levels. In other words, if you invest in a structure product that would pay you 1.5 times of your principal if the CNX Nifty rises 60% from current level in say 3 years, you are expecting that CNX Nifty would trade at about 13, 000 level after 3 years.

There is another version, structure products that don’t target capital protection, usually set the hurdle level on index lower say, 40%. There is a negative side to it, if index fails to cross the level at the end of tenure, you would not only lose interest and but may even lose a part of your capital too.

Typically, the fund manager of the structure product would invest in a debenture at a fixed coupon and would buy an index option which would be exercised only when the predetermined level is attained on Index. Fund management fees are typically 2%-3%.

Are structured products really worth?

PersonalFN believes, apparently these products may look attractive to you but considering the risk involved, they may not be worth investing. While you may opt for the capital protection option, you still run the credit risk. PersonalFN cautions investors with high risk appetite against pitfalls of structured products. You may consider option strategies employed by the fund manager completely safe, but this assumption is very bold. To remind you, Optima option strategy employed by one of the Aditya Birla Group Companies failed and resulted in a loss of over Rs 100 crore. Although living to the reputation, the group assured investors to compensate for these losses (even when there wasn’t any such legal binding) you may not always be protected in such a manner. Furthermore, for a minute assume that, you invested in such structured products at the market top of 2007 and 2010; would you have made any money on them? Barring last 4-5 months markets didn’t even rise 30% over their tops of 2007 and 2010. So you would have ended up settling for coupon payments. At worst, if you opted for "no capital protection" options you may even have lost money.

PersonalFN also believes, if you are fairly confident about markets and you believe index can go up by 60%-70%, why not invest in diversified equity mutual funds rather than betting on index linked products? PersonalFN believes your asset allocation is more important in your journey of wealth creation. Timing the market is risky, speculative and thus should be avoided. If you rebalance your portfolio periodically, you need not bother about missing investment opportunities. Your asset allocation must be in line with your financial circumstances and financial goals.

Add Comments