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Pros and cons of structured products

This article is part of
Guide to Structured Products

“In the vast majority of cases the investor will be buying a senior unsecured note. This is a corporate bond where the interest payment is dictated by a formula related to something like the growth in the FTSE 100.

“This sits as liability on the issuer’s balance sheet. They will owe the client whatever the defined returns are at maturity whatever happens.

“The bank itself will buy and sell derivative contracts and fixed interest securities that together create the returns that they are obligated to pay the client. However the client does not ‘own’ any of these securities.

“Theoretically the bank could take investors’ money and put it on the 4:30 at Chepstow and lose it all. At the end of the term they will still owe the client the returns promised from the product.

“The fact that they have ‘spent’ the investors’ money is irrelevant. Of course in real life the regulators might have something to say about such cavalier management of a bank’s balance sheet.

“Hopefully though this illustrates the reality of the relatively simple (compared to say absolute return funds or with profits) asset the investor buys and the undoubtedly complex actions a bank will be taking to ensure that they are in a position to meet their liabilities.”

But Graham Devile, managing director of Meteor Asset Management, says a structured product is not a savings account, nor is it a magic route to attractive returns in a low interest environment.

He says: “When you invest in a structured product, you are generally consenting to accept a degree of risk in exchange for the potential to receive a return which is higher than the risk-free interest rates available.”

But Mr Devile says these products can modify risk by acting as a hedge against an existing portfolio exposure.

He says: “If clients are long or short equities, structures can be used as a hedge against their positions.”

Plus despite the perception that structured products are illiquid, Mr Devile says this is not the case.

He says: “It is now common, under normal market conditions, for the counterparty to act as a market maker, offering fair value for the underlying securities and creating a secondary market.

“While this is not guaranteed, in normal market conditions it would be unusual for this not to be the case.”