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Are structured products good enough? | August 12, 2008 11:42 IST

Amidst the stock market volatility, it is not surprising to find investors who have all but redeemed their investments. Considering the losses incurred, investors are now exploring investment opportunities in avenues beyond equities. These avenues even have a fancy name - structured products.

Structured products, is the latest buzzword among investors and fund houses alike. Many investors are enticed by the investment proposition offered by these products. Fund houses on their part are only willing to launch more products to feed their popularity among investors.

Most investors believe that structured products are designed in a manner that equips them to deliver superior returns. Besides, they also consider them to be less risky.

Before we explore this subject further, let us first understand what structured products are. As the name suggests, these are customised products that comprise of various financial instruments (derivatives, stocks, bonds and debentures, among others) and investment strategies in one investment.

These products were initially made available to cater to the needs of a specific group of investors (mainly high net worth investors). However, they are now being offered to retail investors as well. To that end, the concept of structured products is relatively new for retail investors.

Terms like derivatives, paired trades and equity-linked debentures among others, have enticed a lot of investors into investing in these products. A strong marketing pitch by fund houses combined with fancy terms/investment strategies leads them to believe that structured products are superior to regular mutual funds. However, there are certain elements that investors need to consider before investing in structured products.

While the advantages offered by structured products are widely-advertised, investors would do well to understand their downside in order to make an informed investment decision. We put forth some of the disadvantages associated with structured products.

Structured products are not as simple as they are usually made out to be; they are quite complex. Since they use a blend of investment strategies, it is difficult for most investors to understand the strategy driving the fund. Expectedly, investors aren't aware of the situations when the strategy might fail to deliver.

Fund houses usually compare the indicative return on structured products with other seemingly comparable instruments. While there is nothing wrong in doing so, the problem arises when the returns are misrepresented. For instance, one of the recently launched structured products compared its indicative returns, in absolute terms, with returns in CAGR (compounded annualised growth rate) terms, offered by another seemingly similar instrument. Both these measures are incomparable.

For example, a 15 per cent return (in absolute terms) over 2 years would actually mean 7.24 per cent CAGR over a similar time frame. However, if investors are being led to believe that the structured product will yield a 15 per cent CAGR over a 2-Yr period when it's likely to deliver a 15 per cent absolute growth over a 2-Yr period, it's a case of misrepresentation. To that end, comparing such returns would lead investors to making a wrong investment decision.

Capital protection
Most structured products belong to the capital protection category. In other words, they aim to protect the investor's capital in any market condition. Given that the larger portion of the fund is invested in debt and the rest is invested in equity, the chances of achieving the stated objective appears to be high. However, these products do not talk about the credit risk involved in the debt component. Although these funds aim to protect the investor's capital, the chance of the fund not achieving the same does exist.

All season fund
Some of the structured products claim to perform across market conditions. Too good to be true, isn't it? This is simply because, these products are designed in such a manner that if the fund manager runs out of investment options, the fund can have a higher cash component. Subsequently, the fact that this will hurt the fund's performance is rarely revealed.

What should investors do?
Investments in instruments like structured products should be made only after there is a clear understanding of its investment proposition, risks involved and the returns projected. If the investor can unravel the structure and can take on the risk for that additional return, then he can consider investing in them. The investor who finds the process of evaluating them difficult, must render the services of a competent financial planner and take a well-informed decision accordingly.

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