The Ever-Changing Investment World We Live In
Since the tech boom of the early 2000s, we have witnessed the financial landscape evolve rapidly in the past decades. An ever-increasing phrase that I hear is “Structured investment Products”.
Structured investment products can come in the form of many guises and can be different investments that just share this one generic name.
With increasing global economic integration, the investment market is bulging with new and exciting investment products. From Cryptocurrency to NFTs the options to invest in complicated assets have never been greater.
Among these, one term that continually resonates with expat investors is “Structured Investment Products.”
Through this guide, we will dive deep into understanding structured investment products, what their benefits are and the risks attached.
If you have read many of our blogs you may have seen us write “You need to invest into a structured investment” or “The added benefits of investing into products with a structure”.
When investment managers write these terms, generally speaking, they are talking about saving your money into an investment with a set of rules and a structure to help you invest your money. Investments like a monthly savings account that you can read about here.
This is where it gets a bit more complicated because “Structured Investment Products” can also come in the form of “Collaterliised Debt Obligations” (CDOs) or in the form of “Structured Notes”, to give you two as an example.
Both of these investments are complicated to understand and I only advise experienced investors to invest in them.
If you are an amateur investor, then structured investment products are probably not a good choice as they go against our ethos of; “Only invest in products that are simple and that you fully understand”.
First of all, let us put things into context and talk about stocks and shares and their relationship with structured investment products.
Socks & Shares Similar & Structured Investment Products
I always tell my clients not to invest in single stocks.
In my opinion, the risk of single stock investing is too high. The ability to pick individual stocks successfully on an ongoing basis is difficult. Investments like this should be left to the professionals. But even then, normal Financial Advice companies and even most fund managers cannot successfully pick stocks and shares or trade funds regularly, which warrants the time effort, and fees associated with it for you to beat the index.
However, in most of the investments which we manage and advise on, the underlying assets are stocks and shares. So on the one hand I’m saying don’t buy them and then on the other, we are buying them.
This same theory can apply to structured investment products. Our advice would be to not singularly or personally buy them. If an experienced trader with a proven track record can buy them successfully, then the same theory applies, let them invest in them for you.
I hope that makes sense, so what are “Structured Investment Products”?
What are Structured Investment Products?
Structured investment products, often referred to as structured investment solutions or structured notes are complex financial derivatives that have been constructed to provide investors with a specific risk-return profile.
Structured Investment for Beginners: Imagine this – you desire the security of fixed deposits and the high returns potential of the stock market.
Structured investment products invest in a collection of underlying assets, such as a stock index, commodities, bonds, currencies, and interest rates, where you can access and gain the growth of the asset, whilst you can also build in a level of capital protection and guarantee an investment return.
Structured investment products are also known as SIPs, which can be read about here on Investopedia.
SIPs are not to be confused with SIPPs, which are Self-Invested Personal Pensions. A SIPP is an investment with a structure but does not go in the category of Structured investment products. You can read about SIPPs here on Wikipedia.
Example of a Structured Note For Beginners
Today we are going to build our own structured investment product. We will call it The European Automobile Structured Note.
We will start by buying shares in VW, Mercedes, Fiat & Renault because we believe the Automobile sector is looking attractive for the next few years. We promise our investors a growth of 12% a year and we will pay this out to them once a quarter, to the tune of 3%, we will do this for the next 36 months, and then we will close the Structured Note and return the capital to our investors.
We will start raising money today and we will give ourselves three months to raise $100 million three months from today when we will close the fund to new money and start the investment from this day forward.
We believe that the automobile sector will grow greater than 12%, so we believe their is a profit to be made. We have put derivatives and options in place which can help us guarantee a return in case there is a market downturn. Derivatives and options are contracts to sell in the future at a pre-arranged price so this will protect us.
However, if the market crashes then we can’t pay our investors so we have set a barrier at 60% of the initial investment amount. This means that if any of these four stocks drop below 60% of the original purchase price, the fund automatically closes. The Structured Note has failed and we hand over the stocks and shares in VW, Mercedes, Fiat & Renault to our client.
The risk for the client is that they do not receive the promised income and their money back at the end, but instead receive a bundle of stocks that are valued lower than the price they bought them at, which in the case of VW, Mercedes, Fiat and Renault is far from catastrophic as they are all very large well-established car companies and the price should bounce back at some point.
Ending up with shares in four high-value car companies is not the worst investment in the world, but you haven’t ended up in the place your investment promised to deliver.
Always look at the worst-case scenario before you enter any investment.
Benefits of Structured Investment Products
Let’s recap on this.
- Customization: Structured investment products can be tailored to fit unique investment goals, risk tolerance, and market views. They are easy to build and can be tailored toward one single rich investor, a financial advice company or the general public.
- Potential for Higher Returns: They often offer returns higher than traditional investment products, especially in low-interest-rate environments.
- Diversification: They allow investors to gain exposure to diverse asset classes, which might otherwise be difficult or expensive to access. Your investment choice is potentially limitless.
How Do Other Structured Investments Work?
The mechanics of structured investment products hinge on a combination of traditional investments and derivatives. For instance, a part of the investment might be used to purchase a bond or a selection of bonds, which ensure a minimum guaranteed return. The remaining funds could be invested in options to provide exposure to equities or other assets that gain growth.
Pros and Cons of Structured Products
While the allure of structured products is undeniable, it’s crucial to understand both sides of the story:
- Potential for Enhanced Returns: Depending on the product’s structure, investors can achieve far greater returns than conventional investments.
- Capital Protection: Some products offer partial or full capital protection, helping minimise potential losses.
- Access to Varied Assets: Structured products allow for investment in diverse markets and assets, enabling a well-rounded investment structure comparison.
- Complexity: These are not straightforward investments. A sound understanding of structured investments is paramount.
- Cost: Due to their complexity they may well come with higher fees compared to traditional investments, something of a taboo subject these days.
- Liquidity Concerns: Not all structured products can be easily sold before maturity, which might pose liquidity issues. You have to expect to be invested for the duration otherwise, don’t invest!
Risks in Structured Investment Products
It’s vital to be wary of the risks involved:
- Market Risk: The return on investment is often linked to the performance of an underlying asset. A downturn in this asset class could influence returns.
- Issuer Risk: If the institution issuing the structured product faces financial troubles, it might affect the product’s performance. There are a multitude of companies that have been offering them for the past fifteen years, as they are easy to build. Use one from a big bank or you can take the risk on a smaller issuer if the investment choice is excellent.
- Complexity Risk: Given their complex nature, there might be unforeseen risks that could affect the investment.
Diversifying with Structured Products
Every investor needs to understand the importance of a fully diversified portfolio and the benefits of being invested in a broad range of asset classes. By incorporating structured investment products into your portfolio, you can achieve a good balance, by offering a fixed return and potentially hedging against losses in one segment with gains in another.
Innovative Structured Investments
As global markets continue to evolve, so do structured products. Innovative structured investments are continually being designed to meet the changing needs of the investment community, ranging from anything like climate-linked products to those tied to tech advancements.
Frequently Asked Questions (FAQs) on Structured Product Risks:
Are Structured Products Safe?
While many offer capital protection, it’s vital to remember that all investments carry risks. Thorough research and understanding of structured investments are essential.
How Does the Structured Product Financial Market Affect My Investment?
The broader financial market’s performance can influence the underlying assets of your structured product, thereby affecting your returns, even when guaranteed.
Structured Product Investment Guide: Final Thoughts
Structured investment products offer a unique blend of security and favourable returns. However, like all investments, they come with their own set of risks. As an expat looking to grow and safeguard your wealth, it’s crucial to delve deep into understanding structured investments, and maybe read some kind of structured product investment guide online, tailored to your needs. This article is a good start.
Always remember, that while the basics of structured product investment remain consistent, the specifics can vary widely. There have been some fantastic offerings and some tragic ones over the years. Think carefully and act accordingly. If used for the right reason with the correct underlying assets then you could be onto a good thing. If anything is too exotic, then I would advise people to stay clear.
If we use the above example: Buying stocks in four of the biggest car companies in the world should always be a reasonable investment despite current world market conditions or the global or political stability of the world.
Engage with a financial advisor, delve into the long-term structured investments available, and ensure your investment choices align with your financial goals. Take a medium-term view and do not expect to be able to exit or sell early. If you cannot commit to the length of the term of structured investment products then just buy an ETF or mutual fund, something that is liquid and traded daily.