Structured products have become popular in institutional investment portfolios. They provide customized solutions to meet specific risk-return objectives. Structured notes are a combination of debt and derivatives. This feature of the structured note helps in principal protection, diversification, and higher returns.
This blog examines the different aspects of structured products, including their advantages, disadvantages, and significance in institutional portfolios.
Structured Products for Institutional Investors
Structured Products for Institutional investors are a combination of two or more financial instruments to achieve the institution’s specific risk-return and investment objectives. These risk and return objectives and specific investment objectives generally cannot be met with other standard financial instruments available in the markets.
These products often combine financial assets, such as Swiss bonds, equities, derivatives, stocks, and other instruments, to create customized investment solutions. Fixed income is derived from bonds to secure the principal amount and higher returns are derived from the equities or derivatives component.
Over the years- structured products have become a popular choice with institutional investors, but one cannot avoid that they come with some risk. Financial advisors help institutional investors make informed decisions in the selection of structured products to achieve the financial goal of the institution. There are many structured products you can choose from.
Key Characteristics of Structured Products for Institutional Investors:
1. Customization:
Structured products can be tailor-made to meet risk-return objectives and investment objectives. The customization helps institutional investors to achieve their investment goals.
2. Risk-Return Profile:
Institutional investors can choose the risk-return profile, from total principal protection, and partial principal protection to high-risk, high-return strategies.
3. Underlying Assets:
The performance of structured products is often linked to the performance of one or more underlying assets. They are often linked to equities, indices, commodities, currencies, and interest rates from bonds. The institutional investor can choose the structured product based on the underlying asset they would like to invest in.
4. Complexity:
Structured products can be complex and require deep knowledge and understanding of the underlying components and how they interact. The institutional inventors will need to analyze the complexity for the best results. The pricing of the structured bond and payoff structure can be difficult to understand.
5. Liquidity:
The structured products are illiquid, so the institutional investor will have to wait till maturity. However, an institutional investor can select a tenure that is suitable for the institution. Also, some structured products can be traded on the secondary market.
6. Regulation:
Structured products will have different regulatory frameworks for different jurisdictions and can affect the design, distribution, and marketing of these products.
7. High Value Investment:
There are not many places where we can invest high amounts easily. The minimum investment value for structured products is $100,000. The Structured Product is an excellent option if you are looking for a high-value investment. If you have a huge sum to invest, you can consider investing in Structured Products.
Types of Structured Products
The Structured products are divided into three categories, based on the risk level at maturity.
- Structured Deposits:
Structured deposits usually have a zero coupon bond and an option component. The zero coupon bond is issued at a discount on its maturity value and the remaining amount is used to purchase the option of an underlying asset.
For example, let us say the zero coupon bond is bought at 80% of its maturity value. The remaining 20% is invested in the option of the underlying asset. So 20% will be invested in the stock market in the call option if the stock market is bullish. When the stock market goes up the call option will capture the upside gains.
- Structured Capital Protected Products :
These types of products give capital protection at the time of maturity. They are often the debt instruments by financial institutions and banks. The investors may lose only in case the issuer of the bond goes Bankrupt, which is a rare case. A small portion of the capital is invested in derivatives for higher returns.
- Structured Capital At Risk Products:
These types of products do not give capital protection or a money-back guarantee. They offer the highest rate of return as the risk is also high. The investor may lose money if the market crashes. The return is based on the value of the underlying asset. A small portion of the capital is invested in Swiss bonds.
Advantages and Disadvantages of Investing in Structured Products
Advantages
- Potential for Higher Risk-Adjusted Returns
Structured products can include various asset classes which can increase returns and decrease portfolio volatility. The higher the risk the institutional investor takes, the more the returns.
- Access to New Markets
Structured Products offer access to markets and asset classes that might not be readily accessible or could be expensive for institutional investors. Institutional investors can take advantage of exploring different types of markets.
- Customized Risk/Return Profiles
Institutional investors can customize structured products based on the risk-return profile and investment goals. Institutions can invest in low-risk and high-return structured products where the initial investment is got back through bonds.
- Diversification
Structured Products are a combination of two or more financial instruments, making it a diversified financial product.
Disadvantages/ Risks
1. Complexity:
Structured products are complex to understand. The pricing and payoff structure of structured products can be difficult to understand. The institutional investor has to research and analyze thoroughly before investing.
2. Market Price Fluctuations:
Structured products can be highly sensitive to changes in the market value of the underlying assets such as stocks, currency, commodities, derivatives, etc. If the markets go down then the value of the product also goes downside. Structured products are highly dependent on market conditions.
3. Credit Risk or Issuer Risk :
The bonds are issued by financial institutions (third-party or counterparty) which is a debt on the company. If the issuer is unable to meet its obligation due to financial crisis or bankruptcy or liquidation of the institution the institutional investor is at risk. The issuer’s creditworthiness is very important.
4. Liquidity Risk:
Structured products cannot be withdrawn until the maturity date. There is a lack of liquidity. Some structured products can be sold in the secondary market.
5. Lack of Price Transparency:
The price of structured products is different for different products. There is no standard pricing for structured products. It could lead to high costs if not scrutinized properly.
Conclusion:
Structured products for institutional investors are investment products that offer the institutions to achieve the risk profile, return objective, and investment objective.
Structured products need to be carefully analyzed by the institutions before investing as there are some risks involved on the flip side. You should also examine thoroughly the different types of structured products before investing. The advice of the financial advisor is crucial before investing in structured products.
