Structured products the
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Publication: The Business Times, p I1 Date: 4 July 2011 Headline: Structured products - the basics Structured products - the For those willing to do their homework, these 'customer-centric products' could in fact be a good option, reports TEH SHI NlNG OR the investing newbie, struc- tured products is a term still taint- ed by the memory of retail inves- a tors losing hundreds of millions invested in products linked to the bankrupted Lehman Brothers when the 2008 financial crisis erupted. Yet, it may be worth ex- ploring more before you dismiss these as a class of investments only the sophisticated, well-heeled investor can touch. For those willing to do their homework and understand each structured product be- fore investing, these "customer-centric prod- ucts" could in fact be a good option to add spe- cific characteristics to a portfolio. After all, they are designed - "structured" - with specific objectives in mind and can thus "create value for investors by offering customised payoffs and risk levels that are dif- ferent from other basic financial instruments such as normal bonds and stocks", says Nan- yang Business School associate professor of fi- nance Low Buen Sin. Still, "the risks of these products are high and they are riskier in volatile markets", so the word of caution from Ang Ser-Keng, sen- ior lecturer of finance at SMU's Lee Kong Chi- an School of Business, is that "young inves- tors should not undertake such investments unless they are experienced or if this invest- ment accounts for a very small part of their portfolio". With that in mind, let's go over some of the basics and some things to consider before in- vesting in a structured product. Structured deposits and structured notes Structured products are typically fixed-term investments that offer some protection on your capital. The term covers a very broad range of "pre-packaged" bundles of more than one in- vestment, which aim to offer a more custom- ised return. This typically involves combining a conventional form of investment with a less conventional one -for instance, creating a sin- gle instrument out of a bond and an option. Financial engineering is that process of cre- ating a new product, usually undertaken by an investment bank. This aims to tailor a whole range of products with different risks and returns, downside protection, income, ex- posure and maturity, by combining underly- ing assets (shares, bonds, indices commodi- ties) with derivatives (options, forwards, swaps) whose value depends on the price of the underlying assets. In Singapore, the two main classes of struc- tured products offered to investors are struc- tured deposits and notes. Dual currency in- vestments, which allow investors to capitalise on narrow exchange rate movements, are con- sidered a sub-set of structured notes. features of structured prod- ucts at www money- sense gou sg Those ~nvest- ing In structured depos~ts, however, can be assured of getting back thelr cap~tal at matur~ty, as long as the bank remains solvent Among the myrlad of structured notes and depos- ~ts out there, broad groups Include + Equ~ty or ~ndex-11nked ones hnked to prlce move- ments of company stocks, Reits, ETFs, market ind~ces + Commodity-l~nked ones wh~ch allocate what's in- vested Into a buy or sell op- tion on a particular com- modity or basket of com- mod~t~es + Inflation-linked ones where Interest payments are linked to the inflation rate wh~le cap~tal is protect- ed * Currency-hked ones to allow investors to take ad- vantage of changes in for- elgn exchange rates, but m t h less risk than direct ex- posure to currencies Before you invest 1 One of the main pitfalls for investors new to structured products is that "the risks that they take are not appar- ent and remote when they first invest in these prod- ucts", says Mr Ang Here are a few t i ~ s for ADAM LEE'ST ILLUSTRATION would-be structured prod- Generally speaking, banks sell structured uct investors: deposits to retail investors, while offering 1. Understand all the key features of the prod- notcs and dual currency investmcnts to more uct. Be aware of: sophisticated customers, such as their private + the main themes of the primary product banking clients. and its derivatives One key difference between structured + conditions attached to the minimum as- notes and deposits is that an investor may po- sured interest rate, if there is one tentially lose his entire principal sum when in- + formulae used to calculate coupons and the vesting in structured notes, says the national maturity return, scrutinising what the worst- financial literacy programme MoneySENSE's case performance may be guide to structured notes, which details other + the variable maturity period, and whether the bank has the right to call or redeem the structured deposit before maturity. 2. Think about your future cash flow needs Structured products are illiquid. You must hold the product to maturity, which can be as short as two weeks or as long as five years. Otherwise, you could lose a substantial part of your initial capital paying what banks call a "premature withdrawal fee". 3. What capital protection does and does not mean Under a structured deposit, though not a structured note, you are likely to get what you invest back. But this depends on the bank stay- ing solvent, and structured deposits are not covered by deposit insurance. "Capital protection is not the same as capi- tal guaranteed," says Prof Low. "We should know that even a simple $100,000 fixed de- posit is not capital guaranteed. The investor will suffer a capital loss if the bank goes into bankruptcy. A capital protected structured product is protected against market risk, not credit risk." This means that a structured product that is capital protected can still be a very high risk instrument if bundled within it are financial instruments with high credit risk, such as the sub-prime mortgage loans blamed in 2008. 4. Other risks + Inflation risk: Even if you get back the prin- cipal sum invested, if the product's returns do not keep pace with inflation, you may still in- cur a loss in real terms as inflation erodes the purchasing power of your capital. + Interest-rate risk: If market interest rates rise while your capital is locked away in the structured deposit, for instance, you will for- feit potential gains on the higher interest rate. So the longer the maturity period, the greater your interest-rate risk is. + Counter-party risk: A structured product's underlying derivative arrangements mean that if a third party goes bust and cannot fulfil its obligation, the structured note for instance could be unwound, to the investor's loss. "Structured products can be very complex instruments, some are not easy to compre- hend, even for very seasoned wealth manag- ers," says Prof Low. So, what has been a constant refrain in this series on basic investing - "Don't put your money in what you don't understand" - is especially relevant here, given the potential complexity of structured products. Source: The Business Times O Singapore Press Holdings Limited. Permission required for reproduction.
Transcript of Structured products the
Publication: The Business Times, p I 1 Date: 4 July 201 1 Headline:
Structured products - the basics
Structured products - the For those willing to do their homework, these 'customer-centric products' could in fact be a good option, reports TEH SHI NlNG
OR the investing newbie, struc- tured products is a term still taint- ed by the memory of retail inves-
a tors losing hundreds of millions invested in products linked to the bankrupted Lehman Brothers when the 2008 financial crisis erupted. Yet, it may be worth ex-
ploring more before you dismiss these as a class of investments only the sophisticated, well-heeled investor can touch.
For those willing to do their homework and understand each structured product be- fore investing, these "customer-centric prod- ucts" could in fact be a good option to add spe- cific characteristics to a portfolio.
After all, they are designed - "structured" - with specific objectives in mind and can thus "create value for investors by offering customised payoffs and risk levels that are dif- ferent from other basic financial instruments such as normal bonds and stocks", says Nan- yang Business School associate professor of fi- nance Low Buen Sin.
Still, "the risks of these products are high and they are riskier in volatile markets", so the word of caution from Ang Ser-Keng, sen- ior lecturer of finance at SMU's Lee Kong Chi- an School of Business, is that "young inves- tors should not undertake such investments unless they are experienced or if this invest- ment accounts for a very small part of their portfolio".
With that in mind, let's go over some of the basics and some things to consider before in- vesting in a structured product.
Structured deposits and structured notes Structured products are typically fixed-term investments that offer some protection on your capital.
The term covers a very broad range of "pre-packaged" bundles of more than one in- vestment, which aim to offer a more custom- ised return. This typically involves combining a conventional form of investment with a less conventional one -for instance, creating a sin- gle instrument out of a bond and an option.
Financial engineering is that process of cre- ating a new product, usually undertaken by an investment bank. This aims to tailor a whole range of products with different risks and returns, downside protection, income, ex- posure and maturity, by combining underly-
ing assets (shares, bonds, indices commodi- ties) with derivatives (options, forwards, swaps) whose value depends on the price of the underlying assets.
In Singapore, the two main classes of struc- tured products offered to investors are struc- tured deposits and notes. Dual currency in- vestments, which allow investors to capitalise on narrow exchange rate movements, are con- sidered a sub-set of structured notes.
features of structured prod- u c t s a t w w w money- sense gou sg Those ~nvest- ing In structured depos~ts, however, can be assured of getting back thelr cap~tal at m a t u r ~ t y , a s long a s the bank remains solvent
Among the myrlad of structured notes and depos- ~ t s out there, broad groups Include + Equ~ty or ~ndex-11nked ones hnked to prlce move- ments of company stocks, Reits, ETFs, market ind~ces + Commodity-l~nked ones w h ~ c h allocate what's in- vested Into a buy or sell op- tion on a particular com- modity or basket of com- m o d ~ t ~ e s + Inflation-linked ones where Interest payments are linked to the inflation rate wh~le cap~tal is protect- ed * Currency-hked ones to allow investors to take ad- vantage of changes in for- elgn exchange rates, but m t h less risk than direct ex- posure to currencies
Before you invest 1 One of the main pitfalls for
investors new to structured products is that "the risks that they take are not appar- ent and remote when they first invest in these prod- ucts", says Mr Ang
Here are a few t i ~ s for ADAM LEE'ST ILLUSTRATION would-be structured prod-
Generally speaking, banks sell structured uct investors: deposits to retail investors, while offering 1. Understand all the key features of the prod- notcs and dual currency investmcnts to more uct. Be aware of: sophisticated customers, such as their private + the main themes of the primary product banking clients. and its derivatives
One key difference between structured + conditions attached to the minimum as- notes and deposits is that an investor may po- sured interest rate, if there is one tentially lose his entire principal sum when in- + formulae used to calculate coupons and the vesting in structured notes, says the national maturity return, scrutinising what the worst- financial literacy programme MoneySENSE's case performance may be guide to structured notes, which details other + the variable maturity period, and whether
the bank has the right to call or redeem the structured deposit before maturity. 2. Think about your future cash flow needs Structured products are illiquid. You must hold the product to maturity, which can be as short as two weeks or as long as five years. Otherwise, you could lose a substantial part of your initial capital paying what banks call a "premature withdrawal fee". 3. What capital protection does and does not mean Under a structured deposit, though not a structured note, you are likely to get what you invest back. But this depends on the bank stay- ing solvent, and structured deposits are not covered by deposit insurance.
"Capital protection is not the same as capi- tal guaranteed," says Prof Low. "We should know that even a simple $100,000 fixed de- posit is not capital guaranteed. The investor will suffer a capital loss if the bank goes into bankruptcy. A capital protected structured product is protected against market risk, not credit risk."
This means that a structured product that is capital protected can still be a very high risk instrument if bundled within it are financial instruments with high credit risk, such as the sub-prime mortgage loans blamed in 2008. 4. Other risks + Inflation risk: Even if you get back the prin- cipal sum invested, if the product's returns do not keep pace with inflation, you may still in- cur a loss in real terms as inflation erodes the purchasing power of your capital. + Interest-rate risk: If market interest rates rise while your capital is locked away in the structured deposit, for instance, you will for- feit potential gains on the higher interest rate. So the longer the maturity period, the greater your interest-rate risk is. + Counter-party risk: A structured product's underlying derivative arrangements mean that if a third party goes bust and cannot fulfil its obligation, the structured note for instance could be unwound, to the investor's loss.
"Structured products can be very complex instruments, some are not easy to compre- hend, even for very seasoned wealth manag- ers," says Prof Low.
So, what has been a constant refrain in this series on basic investing - "Don't put your money in what you don't understand" - is especially relevant here, given the potential complexity of structured products.
Structured products - the For those willing to do their homework, these 'customer-centric products' could in fact be a good option, reports TEH SHI NlNG
OR the investing newbie, struc- tured products is a term still taint- ed by the memory of retail inves-
a tors losing hundreds of millions invested in products linked to the bankrupted Lehman Brothers when the 2008 financial crisis erupted. Yet, it may be worth ex-
ploring more before you dismiss these as a class of investments only the sophisticated, well-heeled investor can touch.
For those willing to do their homework and understand each structured product be- fore investing, these "customer-centric prod- ucts" could in fact be a good option to add spe- cific characteristics to a portfolio.
After all, they are designed - "structured" - with specific objectives in mind and can thus "create value for investors by offering customised payoffs and risk levels that are dif- ferent from other basic financial instruments such as normal bonds and stocks", says Nan- yang Business School associate professor of fi- nance Low Buen Sin.
Still, "the risks of these products are high and they are riskier in volatile markets", so the word of caution from Ang Ser-Keng, sen- ior lecturer of finance at SMU's Lee Kong Chi- an School of Business, is that "young inves- tors should not undertake such investments unless they are experienced or if this invest- ment accounts for a very small part of their portfolio".
With that in mind, let's go over some of the basics and some things to consider before in- vesting in a structured product.
Structured deposits and structured notes Structured products are typically fixed-term investments that offer some protection on your capital.
The term covers a very broad range of "pre-packaged" bundles of more than one in- vestment, which aim to offer a more custom- ised return. This typically involves combining a conventional form of investment with a less conventional one -for instance, creating a sin- gle instrument out of a bond and an option.
Financial engineering is that process of cre- ating a new product, usually undertaken by an investment bank. This aims to tailor a whole range of products with different risks and returns, downside protection, income, ex- posure and maturity, by combining underly-
ing assets (shares, bonds, indices commodi- ties) with derivatives (options, forwards, swaps) whose value depends on the price of the underlying assets.
In Singapore, the two main classes of struc- tured products offered to investors are struc- tured deposits and notes. Dual currency in- vestments, which allow investors to capitalise on narrow exchange rate movements, are con- sidered a sub-set of structured notes.
features of structured prod- u c t s a t w w w money- sense gou sg Those ~nvest- ing In structured depos~ts, however, can be assured of getting back thelr cap~tal at m a t u r ~ t y , a s long a s the bank remains solvent
Among the myrlad of structured notes and depos- ~ t s out there, broad groups Include + Equ~ty or ~ndex-11nked ones hnked to prlce move- ments of company stocks, Reits, ETFs, market ind~ces + Commodity-l~nked ones w h ~ c h allocate what's in- vested Into a buy or sell op- tion on a particular com- modity or basket of com- m o d ~ t ~ e s + Inflation-linked ones where Interest payments are linked to the inflation rate wh~le cap~tal is protect- ed * Currency-hked ones to allow investors to take ad- vantage of changes in for- elgn exchange rates, but m t h less risk than direct ex- posure to currencies
Before you invest 1 One of the main pitfalls for
investors new to structured products is that "the risks that they take are not appar- ent and remote when they first invest in these prod- ucts", says Mr Ang
Here are a few t i ~ s for ADAM LEE'ST ILLUSTRATION would-be structured prod-
Generally speaking, banks sell structured uct investors: deposits to retail investors, while offering 1. Understand all the key features of the prod- notcs and dual currency investmcnts to more uct. Be aware of: sophisticated customers, such as their private + the main themes of the primary product banking clients. and its derivatives
One key difference between structured + conditions attached to the minimum as- notes and deposits is that an investor may po- sured interest rate, if there is one tentially lose his entire principal sum when in- + formulae used to calculate coupons and the vesting in structured notes, says the national maturity return, scrutinising what the worst- financial literacy programme MoneySENSE's case performance may be guide to structured notes, which details other + the variable maturity period, and whether
the bank has the right to call or redeem the structured deposit before maturity. 2. Think about your future cash flow needs Structured products are illiquid. You must hold the product to maturity, which can be as short as two weeks or as long as five years. Otherwise, you could lose a substantial part of your initial capital paying what banks call a "premature withdrawal fee". 3. What capital protection does and does not mean Under a structured deposit, though not a structured note, you are likely to get what you invest back. But this depends on the bank stay- ing solvent, and structured deposits are not covered by deposit insurance.
"Capital protection is not the same as capi- tal guaranteed," says Prof Low. "We should know that even a simple $100,000 fixed de- posit is not capital guaranteed. The investor will suffer a capital loss if the bank goes into bankruptcy. A capital protected structured product is protected against market risk, not credit risk."
This means that a structured product that is capital protected can still be a very high risk instrument if bundled within it are financial instruments with high credit risk, such as the sub-prime mortgage loans blamed in 2008. 4. Other risks + Inflation risk: Even if you get back the prin- cipal sum invested, if the product's returns do not keep pace with inflation, you may still in- cur a loss in real terms as inflation erodes the purchasing power of your capital. + Interest-rate risk: If market interest rates rise while your capital is locked away in the structured deposit, for instance, you will for- feit potential gains on the higher interest rate. So the longer the maturity period, the greater your interest-rate risk is. + Counter-party risk: A structured product's underlying derivative arrangements mean that if a third party goes bust and cannot fulfil its obligation, the structured note for instance could be unwound, to the investor's loss.
"Structured products can be very complex instruments, some are not easy to compre- hend, even for very seasoned wealth manag- ers," says Prof Low.
So, what has been a constant refrain in this series on basic investing - "Don't put your money in what you don't understand" - is especially relevant here, given the potential complexity of structured products.
