The Market is a Match for Structured Investment Products
After a strong recovery post Covid and an unpredictable start to 2022, the year to date has been challenging, partly as a result of extreme market volatility.
In October, US markets moved more than 5% in one day, the biggest swing in recent history. However, trying to time exposure to equity markets is tricky, and political and economic uncertainty makes it all the more challenging. While there is still an opportunity to invest in equity markets, it’s crucial that investors are able to effectively manage the downside risk, should these markets experience a material drawdown.
An increasingly attractive solution for this particular market challenge is a structured investment product. A pre-packaged, fixed-term investment, it offers retail investors the advantage of easy access to local and offshore equity markets, while also providing partial or full capital protection at maturity, should these markets fall. In essence, investors receive exposure to the upside of equities, but at a predefined, reduced level of risk or loss of capital.
Designed to form part of a well-balanced and diversified investment portfolio, structured products can specifically add value where low investment returns are expected (and the investor can leverage the performance to produce a high return) or where investment markets are expensive or volatile, as is currently the case.
How does it work?
The issuer of the structured product uses asset classes like equities, bonds and derivatives, to structure a particular performance and risk profile for the investor. This is called the pay-off profile and refers specifically to the balance between downside protection (i.e. capital protection) and upside participation, (i.e. the level of participation in the investment growth).
It makes sense, therefore, that cautious investors may opt for a higher level of capital protection with a corresponding lower eventual investment return, while more aggressive investors are likely to be more comfortable with less capital protection and a higher level of growth participation. They may even wish to leverage their upside to yield outsized returns if the market provides a certain result.
Some structured products are offered in offshore currency terms and linked to offshore markets like the S&P500, the FTSE100 or the Eurostoxx50. Others may be Rand-based, even though the payoff profile is based on an offshore market, as well as currency appreciation or depreciation.
Be aware of the risks
As with all investments, there are certain risks involved with investing in a structured product. These include counterparty- or credit risk, which relates to the financial institution providing the guarantee of capital protection or enhanced return, and its ability to make the required promise upon the maturity of the structured product.
The next is liquidity risk. As structured products are designed for a set investment period of up to five years, in order to receive the full benefit, it would more often than not be advisable for investors to remain invested to maturity. However, it is mostly possible to withdraw funds prior to maturity, but in doing so, any protection inherent in the product may be stripped away, which could result in capital losses, should the underlying assets be priced at a loss.
Finally, structured products do not pay dividends, and while there is slight compensation for this in the gearing offered, there is no yield.
During times of insecurity, capital protection of any kind is a sought-after benefit. This, coupled with the possibility of an enhanced investment return, is an attractive combination. Each year various insurers and investment companies issue numerous local and offshore structured products, each with their own underlying characteristics. With the guidance of an experienced, independent investment professional, investors should be able to identify products best suited to their individual risk profile and performance objectives.
