Structured products: what is it and is it worth investing in them

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Structured products: Alexander has already invested part of his free money in stocks and bonds . Now he was interested in structural products. According to the broker, they can give more income than ordinary bonds, while the risks are less than when investing in stocks. We figure out if this is true and whether Alexander should try a new instrument.

What are Structured products?

A structured product is a constructor of several financial instruments. It may include deposits or bonds, as well as futures and options. At the same time, the yield on deposits is fixed, on bonds it is most often known in advance, and on futures and options it is unpredictable.

The seller determines the set of instruments that will make up the structured product and sets the conditions under which you will make a profit. For example, you will be able to earn with the growth of the share price of the ten largest Russian IT companies from 5 to 12%. If these conditions are met by the end of the contract, you will be credited with a higher income than on deposits and bonds. And if not, you will not earn anything or even lose. The conditions under which you can count on profits are usually called an investment idea or an investment strategy .

An investment idea always consists of several conditions. For example, a seller of a structured product assumes that the stock market will remain stable and stock prices will not fluctuate much. It includes the bonds of the Udod and Kompot companies, as well as options to purchase shares of the Kingfisher and Sandwich companies in the structural product . After three months, you will receive a 20% return on investment if the following conditions are met:

  • during this time, the Udod and Kompot companies will not default on the bonds  – they will not refuse to redeem them and pay coupon income on them;
  • in three months, the shares of the Kingfisher and Sandwich enterprises will not change in price – they will not fall in price and will not rise in price – by more than 10%.

If at least one condition is violated, you will not earn anything – you will get back as much as you contributed.

How risky are structured products?

The risk depends on the degree of capital protection. Structural products can be divided into three categories:

  • With full capital protection. The profitability of products with full protection, as a rule, is small. Their advantage is that the seller of a structured product undertakes to return all the money invested to you if the investment idea does not materialize. But in this case, there may not be any income.
    Structured products with full capital protection will suit cautious investors.
  • With partial capital protection. In any situation on the market, you will be returned a certain share of investments, for example, 30%. But whether you can earn something or at least avoid losses depends on the conditions of the investment strategy.
    For example, an investor buys a structured product, the payouts for which are tied to the share prices of only one company – Kingfisher. If the price of Kingfisher shares does not fall or falls by no more than 15% in a year, then the investor will receive a return of 20%. If the fall is from 15 to 30%, then he will be paid 60% of the invested amount. If the shares fall in price by 30–70%, then the investor will receive Kingfisher shares for the entire amount invested. In this case, the share price will be calculated at the time of purchase of the structured product. That is, the investor will find himself in a situation as if a year ago he bought not a structural product, but the shares of Kingfisher itself. Shares will lose in price, for example, 40% – and the losses will amount to just 40%. If the value of the shares collapses by 70% or more, exactly 30% of the invested amount will be returned to the client. This option is suitable for investors who are willing to take risks for the sake of a large income.
  • No capital protection. Such products are often perpetual, that is, they do not provide for repayment on a specific date at all. You can buy and sell them at any time, and your profit or loss will depend only on the change in the price of the product.
    The price of such structural products is pegged to the underlying asset – most often to the exchange index. But fluctuations in the price of a structural product can be larger than fluctuations in the index. For example, if the index dipped by 10%, the price of a product could fall by 20%. And if the index rose by 10% – rise by 20%.
    Structured products without capital protection are suitable only for the most experienced investors who can predict the movement of indices and make quick buying and selling decisions.

Investing in a structured product with full capital protection may be less risky than buying shares. After all, full protection means that you can return the invested money in any situation on the stock market – however, provided that the company from which you bought the structured product does not go bankrupt. But if the investment idea does not justify, you will not receive income.

For example, if you buy shares of Kingfisher and Sandwich companies, and they fall in price, then you will lose part of your capital. And under the terms of the structured product with full capital protection, which includes these shares, you simply will not make a profit, but there will be no losses either.

True, if under the contract the money is returned to you only after a few years, investments may depreciate due to inflation. In addition, structured products, including those with full capital protection, as a rule, do not allow you to withdraw money ahead of schedule. If you want to terminate the contract ahead of time, you will either not get anything back at all, or you will be paid much less than you paid.

Investing in structured products with little or no capital protection tends to be even riskier than buying real assets. The losses may be greater than what you would lose if the share price went down.

If the investment idea of ​​such products does not justify itself, you can lose money even in a situation where the stock market is growing and assets are becoming more expensive.

For example, the shares of Kingfisher and Sandwich companies will grow by 15%, and according to the terms of the strategy, growth should not exceed 10%. As a result, your investments in a structured product will not be profitable. You will not receive income. And if you just bought the same securities, you would earn by increasing the price of shares and coupon income on bonds.

Structured products may include any other conditions: growth or fall of the exchange rate within certain limits, changes in prices for precious metals, fluctuations in stock indices.

Calculating the gain or loss on structured transactions or securities is usually quite difficult even for experienced investors. In fact, this is another risk – not to take into account all the subtleties of the structured product.

If you do not have the opportunity or desire to understand the features of structural instruments, it is better to choose simpler assets – deposits, reliable shares or bonds, shares of open-ended or exchange-traded mutual funds.

What are Structured products?

There are two types of structural products:

  1. structured deals. You enter into an agreement with a bank, broker, trustee or insurance company. This contract spells out what income or loss you will receive and under what conditions. The agreement is valid for a fixed period. If you terminate it early, you will receive back less money than you deposited.
    There are two types of structured transactions on the Russian market – a structured deposit and  a structured transaction with a bond portfolio .
  2. Structural securities.
    You buy a security – and its profitability or loss is specified in the terms of issue. Theoretically, you can sell it at any time. But in practice, it is rarely possible to do this quickly and without great losses. Structural securities also come in two types – structural bonds and  structural notes .

Let us consider in more detail the features of each type of structural products.

Structural deposit

Such deals are most often offered by banks. Sometimes they are also called investment or indexed deposits.

The client is allowed to sign two agreements at once – a bank deposit and a derivative financial instrument. A person opens a fixed income deposit. The bank pays interest on it in advance, but immediately invests this interest in options or futures. If the investment idea of ​​the bank justifies itself, the depositor will receive more income than the interest on the deposit. If the investment strategy of the bank is unsuccessful, then the client will receive back only the amount of the deposit – without interest.

For example, you are offered to invest 100,000 dollars in a structural deposit for a year at 8% per annum. But instead of paying income on the deposit (8,000 dollars at the end of the deposit term), they immediately sell you an option for this amount. Let’s say an option to buy shares of Kingfisher.

According to the investment strategy, if in a year the shares of Kingfisher will rise in price by no more than 20%, then you will make a profit of 15,000 dollars. That is, you will earn more than if you put money on a regular deposit.

But if the stock goes down or rises in price by more than 20%, you won’t win anything. In a year, only your 100,000 dollars will be returned.

An option or futures can be for the purchase of any liquid asset that can be quickly sold on the exchange at a market price. Most often they offer options to purchase shares of the largest Russian or foreign companies, as well as shares of exchange-traded funds – ETFs.

In addition to banks, structural deposits can be offered  by trustees and insurance companies as part of investment life insurance (ILS).

In the case when a structured deposit is offered by a bank, the amount of the deposit (without interest) is protected by the deposit insurance system . If the bank’s license is revoked, you are guaranteed to be able to return the money invested within 1.4 million dollars. If you purchase a structural deposit through other companies, then the state insurance for this money will not apply.

In addition, unlike ordinary deposits, structured deposits cannot be withdrawn ahead of schedule.

Structured transaction with a portfolio of bonds

Such structured transactions are offered by insurance companies within the ILI, as well as trustees and brokers.

Do not forget that the money you invest in their products does not fall into the deposit insurance system. Plus, the possibility of losing money is built into the terms of many structured trades.

Under ILI policies, the insurance company does not guarantee income, but usually prescribes in the contract that the amount of money invested will be returned to you in any case. Even if the investment fails.

If you enter into a structured transaction with a broker or trustee, then you yourself choose how much you are willing to risk. The risk level can range from 0 to 100% of the money invested.

Zero risk means that in the worst case, you will get back exactly as much as you deposited into the account of the broker or trustee. Such transactions are also called transactions with full capital protection.

The higher the interest rate you choose, the greater the proportion of money you are willing to lose. For example, at a risk level of 20%, you determine that you are ready to lose no more than 20% of your investment. This option will be called partial protection.

You can also choose the option without capital protection – the risk level is 100%. That is, in a bad scenario, you will lose all the money.

For example, a broker offers you a structured trade for a year. The broker’s investment idea is that the S&P 500 stock index (a portfolio of shares of the 500 largest US companies) will not rise or fall by more than 15%. You deposit 100,000 rubles to the brokerage account and enter into a structured deal with the broker with the condition of full capital protection.

Then you give the broker two instructions. The first is to buy a portfolio of fixed-income bonds. The second is for buying and selling options or futures. Adhering to your risk level, the broker will invest 90,000 rubles in corporate bonds of the largest Russian and Western companies. And the remaining 10,000 rubles – in futures or options.

If the broker’s investment strategy works, you will receive a return of 20% per annum. That is, in a year the broker will pay 120,000 dollars. If not, they will return your 100,000 dollars. In case of losses on futures or options, the broker will cover them with income from bonds.

If you choose partial capital protection or no capital protection option, the broker or manager may offer you more income. For example, 40% per annum with 50% capital protection. But you will receive this income if the investment idea works. If not, then you will lose half of the money invested.

Types of structural securities

Let us consider in more detail the types of structural securities.

Structured bonds

By  law , only banks, brokers, dealers or specialized financial institutions can issue structured bonds.

Structured bonds are coupon bonds with conditional capital protection. That is, the company that issued them, upon redemption, can pay you the full amount of their face value, part of the face value, or pay nothing at all. The amounts of payments are specified in the terms of the bond issue.

In addition to face value, structural bonds can pay two types of coupon income – fixed and variable.

The size of the fixed coupon is known in advance. This coupon may be large, but you will only receive it if the investment strategy pays off. Or, conversely, purely symbolic – about 0.01%. Such a rate will not even cover the commission that a broker or management company will have to pay for the purchase of a structured bond. But in this case, the issuer pays an additional variable income.

The size of the variable coupon often ranges from zero to high interest – 2-3 times higher than for classic bonds. And the terms of the bond issue indicate in which cases what amount you can count on.

The size of the variable coupon is often tied to one of the stock indicators. For example, to the Moscow Exchange index (it includes shares of the largest Russian companies) or the S&P 500 index (combines the shares of 500 leading American companies). Also, the size of the coupon may depend on changes in the exchange rate or the price of a commodity – say, gold or oil.

Structured bonds can be purchased through a broker or trustee. Broker services are usually cheaper.

Structured Income Bonds

It is almost the same as structured bonds, but with full capital protection. That is, the bank or company that issued them guarantees to pay the face value of the bonds upon redemption in any situation on the market.

But it should be borne in mind that usually the maturity of such securities is 3-5 years. And if you want to sell them before maturity, you will most likely lose some of the money.

And whether there will be a coupon income and what size – depends on various conditions. For example, whether the price of oil or some stock index will reach a certain value by the time of redemption.

Unlike bank deposits, investments in any bonds do not fall under the deposit insurance system . If the license is revoked from the bank or company that issued them, you will have to wait until the end of the lengthy bankruptcy procedure in order to return your money at least partially.

Structural notes

These securities are issued by Western investment banks. They can be bought through Russian brokers and trustees.

Structured notes are similar to bonds. Usually they have a certain period of life, and at the end of this period they pay the face value of the note (in whole or in part – this is prescribed in the conditions for issuing a note). Plus, you can receive additional payments – either at the end of the note’s validity, or several times during its life (like coupon payments on bonds).

Investment banks tie the yield on these securities to the price of a certain underlying asset. An asset is the shares of one or more companies, oil, gold, stock index. In this case, the binding can be any. Let’s say a bank promises to pay income if the price of an asset falls rather than rises or stays within an agreed price range. If this condition is not met, the bank guarantees the return of only part of the note’s face value.

For example, the yield of a structural note is tied to the change in the price of the Wall-e IT company. If during the year the price of Wall-e shares does not rise or fall by more than 10%, then the investor will receive a return of 20% by the end of the year. If the value of the shares changes by more than 10%, the bank will return to the buyer of the note only 60% of the money invested.

If you are confident that Wall-e shares will be stable in price, there is no point in buying them. Because you can’t make money. But buying a note, on the contrary, will be very profitable. If your forecast is wrong and the shares suddenly increase in price by more than 10%, then you will not only not earn, but also lose 40% of the money invested in the note.

In any case, structural notes for a Russian investor are an even more risky instrument than structural bonds of domestic companies. After all, if the foreign bank that issued them goes bankrupt, you will have to return your money according to the laws of the country in which the bank is registered.

It is also worth considering that investments in any foreign securities are associated with political risks. After the imposition of sanctions, many foreign assets, including structural notes, were frozen. It is impossible to sell them or receive payments on them until the sanctions are lifted.

What do I risk by buying a structured product?

There are several types of risks:

  • Risk of losing possible income
    You can invest in the underlying assets themselves (stocks, bonds, ETFs and other instruments) or in a structured product that is linked to them. And it is impossible to unambiguously predict which investments will be more profitable. There is a possibility that when you buy a structured product, you will lose some or all of the income that you could have received by buying the underlying asset itself.

  • Market risk
    The profitability of any structured product depends on fluctuations in the market prices of the underlying asset. Moreover, there can be any connection: for example, under the terms of a structured transaction, with an increase in prices for certain shares, your income may fall. But structured products with capital protection allow you to at least save the money invested. Products with conditional or partial capital protection or no protection at all can result in unpredictable losses.

  • Liquidity risk
    All structured products have the risk of not being able to sell quickly and at a fair price, but each type of product is different.
    It is very unprofitable to terminate structured transactions ahead of time – you will lose a significant part of the money invested. The amount of losses is prescribed in the terms of the transaction.
    Many structured bonds, structured income bonds and structured notes can only be sold to the bank, broker or management company from which you purchased them. At the same time, the terms of the agreement often specify that they are not obliged to redeem the paper ahead of time. And when early redemption is possible, only part of the face value will be returned to you.
    Some structured securities are traded on an exchange. They can be sold at any time before maturity, but it is likely that the sale price will be lower than the price at which you bought them. As a result, instead of income, you will receive losses.
    Holders of some foreign structured securities face additional problems – their assets cannot be sold due to sanctions.

  • The risk of default on bonds and non-return of deposits included in the product
    Structured products include bonds of reliable companies or deposits of stable banks in order to reduce the risk of losing money due to a fall in the value of other instruments in the structured product. If the company that issued such a bond goes bankrupt, or the bank in which the deposit was opened, then you will lose most of the money invested. Therefore, carefully study what deposits and bonds are included in the insurance product.

  • Bankruptcy risk of a financial institution that created a structured product
    This is the biggest risk. If the entity that issued the structured security or with which you entered into a structured transaction goes bankrupt, it will be difficult to recover the money invested. You will have to wait until the long bankruptcy proceedings are completed. And don’t expect a full refund.

Structured products carry many risks. If you are told that a structured product is the same as a deposit or a bond, only more profitable, this is not true. Even when such an instrument was sold to you at a bank, this does not mean at all that your money is protected by the deposit insurance system . You can lose your investment partially or completely.

What can I gain if I choose structured products?

Structured products can be more profitable and less risky than other investment vehicles. But in reality, everything depends on the situation on the market and the parameters of the structured product.

For example, you can win in the following situations:

  • The stock market is not growing  – stock prices fluctuate around the same level or gradually decline.
    Under such conditions, it will not be possible to make a profit from direct investments in securities. And sellers of structured products can come up with a strategy to capitalize on futures and options in a falling or frozen market.

  • You don’t have enough money for direct investment.
    Foreign securities with high yields are often very expensive – tens and even hundreds of thousands of dollars or euros. You can buy a structured product that is tied to a portfolio of these expensive securities. But in such a situation, it is much less risky to invest in a mutual fund (mutual fund) or ETF, which invests money in foreign stocks or bonds. Unit prices are transparent and returns are more predictable than with structured products.

  • You want to get a higher yield than on deposits and bonds, but you are not ready to lose money.
    Structured products with capital protection will help reduce the risk of investment. But only if you choose a reliable seller of structured products – a bank, insurer, brokerage or management company. Focus on the size of the organization’s assets and its lifespan, and most importantly, find out who its main owners are. This information should be listed on the organization’s website.

Structured products can generate more income than investing in stocks, bonds and deposits through derivative financial instruments. At the same time, large players receive more favorable conditions for derivatives than those available to a private investor. If you try to independently assemble a financial constructor from different instruments, as in a structured product, the profit will be lower.

How much does a structured product cost?

The price difference is very large. A Russian structured bond can cost 1,000 rubles. Foreign structural notes are much more expensive – from $1000. Structured transactions are usually concluded for amounts from several tens of thousands of rubles.

Do not forget that, in addition to paying for the structured products themselves, you will have to pay a commission for the services of a seller – a broker or trustee.

When buying structured securities, you usually know right away what commission you will pay. For example, 2% of the face value of a structured bond.

In structured deals, the commission is often hidden. The seller lays his profit in the parameters of the product itself. For example, under the terms of the deal, you will receive 20% of the return on investment if the broker’s investment idea works. But the real return on investment can be 30 or 40%. The difference between the actual profit and what you get will be the seller’s hidden commission. You will never know the size of this commission.

Who can buy Structured products?

According to the law , only qualified investors can purchase structured notes of foreign investment banks .

All Russian structured bonds are now also destined for “quals” only . Without such a status, it will not be possible to invest in them.

Structural income bonds come with  or without a “qualifier” mark . If qualification is not required, then all investors can invest in securities, but only after testing .

It will allow you to check whether you are well aware of the features of these tools and the risks associated with them.

Any investor can enter into a structured deal . But since these transactions often involve operations with options or futures, you will need to pass testing for these instruments.

For each broker or management company, it is enough to pass the check once – before the first transaction with a risky asset. But if you want to switch to another intermediary, you will have to take the test again.

There are four knowledge testing questions in the test for each instrument. You must choose one of the four suggested answers. For example, you need to calculate the amount of payments on a structured bond at the date of its redemption, taking into account a given level of capital protection and a change in the price of the underlying asset. To successfully pass the test and qualify for instrument operations, you must answer all these questions correctly . You can retake tests as many times as you like.

Restrictions on sales of structural products were introduced for a reason. More often than not, structured securities and structured transactions are very complex. Only experienced investors can understand all the risks and assess what the chances of earning are.

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