What are Structured Investment Products?

The term “structured product” is the name given to an investment with a pre set formula for calculating returns and risk.  The investment is built or structured so that the client knows exactly which underlying asset or market their investment returns are linked to and how the upside gains and downside risks will be worked out.  These are set at the beginning of the investment term and cannot be altered.

The performance of the structured product can be linked to a wide range of markets.  Examples include sharemarket indices, bond market indices, commodity indices and currency markets.

The performance is based on the underlying asset which has been selected.  The returns and risks are secured by using customised financial solutions issued by major global investment banks.

Structured investments that are offered to the retail investor are generally in the form of capital protected products, however structured products can be structured without any capital protection at all.  An example would be collateralised debt obligations (CDO’s).

Typically there are two forms of structured products, growth products and income products.  Growth products pay out a return at maturity and usually have a strong form of capital protection.  Income products provide a regular variable or fixed income but often there is a risk to the capital return at maturity.  Both income and growth products offer returns linked to an underlying asset.

Standard growth products have two main features.  Firstly, the investor’s capital is protected at maturity and secondly investors receive a fixed percentage of the growth in the underlying asset.  This is the participation rate.  If the participation rate is 100%, then investors receive 100% of the rise of the underlying asset.  Participation rates can be more than or less than 100%.

In Europe, structured products have proven to be very popular, with recommendations that up to around 20% of a portfolio be in this form.  This sort of investment product is relatively new to the New Zealand market, so advisers are adopting a cautious approach. 

If investors are going to make use of these style of investments, they need to be aware that they are designed to be held to maturity.  If early redemptions are made, there can be significant capital losses.  This is the main reason as to why only a portion of an investment portfolio should be considered for investment into structured products.

We see the use of structured investment products increasing for a number of reasons.  A major reason is the capital protection, and its ability to reduce volatility within portfolios.  Other reasons include the ability to readily invest into commodities, currencies, high volatility Asian sharemarkets, or other investment markets with relative safety.  On the other hand, because of the effective lock in nature of these investments, taxation treatments may change.  This could prove to be a negative, given the proposed tax changes that the current government is planning on introducing.