What is a structured product? An investment vehicle specifically designed to manage risk.
A structured product is a note with 10 years or less until maturity, usually linked to an underlying stock index or multiple stock indices. (Sometimes the underlying asset is a basket of stocks, a single stock, or a commodities or currency index.)
Structured products are designed for the sophisticated investor who wants to hedge against market downturns.
When the underlying index or security does well, you benefit from the exposure. If it doesn’t do well, you still have your principal protected.
They are akin to an equity version of an index annuity: the potential returns are high, and the risk is low because the investment is built on a debt instrument.
Basic types. There are three core types of structured products: reverse convertibles,
structured notes and index-linked CDs.
As the name implies, a reverse convertible is the reverse (or rather, the inverse) of a standard convertible bond. A convertible bond gives you an option to convert the bond principal to equity shares in the company issuing the bond, through what is basically a call option. A reverse convertible gives the bond issuer that right — the bond issuer essentially holds a put option on the shares of the underlying security.
What does this “reversal” mean for you? Potentially higher yields. If the bondholders exercise the put option, you get equity shares instead of merely principal plus coupons at maturity.
Structured notes. Sometimes called principal-protected notes, these combine a zero-coupon bond with an option on an underlying index, or multiple indices. At their most basic and least exotic, these are buy-and-hold investments with two- to seven-year terms, with principal protection guaranteed by the issuer.
When the market does well, your return reflects market trends. In a down market, you don’t lose the initial principal because it has been invested in a bond product.
Some of these notes have customized structures that allow you to receive a credit if the linked index performs really well. Others are one-year or two-year notes that allow you to benefit regardless of whether the index you select gains or loses volume for the stipulated time period — as long as the dollar value of the underlying index does not surpass or drop below the “barrier” limits set at inception, you receive a return equal to the dollar value movement, whether it is positive or negative. Other types of structured notes aren’t completely principal-protected, reducing the level of protection in exchange for the potential of a better return.
Index-linked CDs. Here we have a structured product with FDIC protection. Your principal isn’t invested in a zero-coupon bond, but in an insured, zero-coupon certificate of deposit linked to one or more underlying indices.
Personalized per investor. Structured products can be customized to suit an investor’s particular risk/reward objectives. For the conservative investor, they present intriguing alternatives to standard asset classes.
Do you need to hedge? Are you at a point in life where preservation of principal needs to come first? If so, you might want to take a closer look at structured products. Before you decide to move any assets into these cutting-edge investments, be sure to arrange a talk with a qualified financial advisor who understands structured products thoroughly.