SIMON BROWN: Understanding the T&Cs of structured products

Local structured products have grown in popularity, offering, in the simplest sense, degrees of downside protection and enhanced returns. They were once available only to those with large portfolios, but we’re seeing lower minimums and many brokers are now offering them to clients, putting them in reach for most investors.

As a concept, structured products are great, but investors need to fully understand the terms and conditions (T&Cs).

The first is a lock-in period. Structured products typically require a commitment of three to five years, during which exiting is either not an option or will come at a cost. Early exit will be facilitated by the product being listed on an exchange, but it is likely to be at a discount to its current value — potentially a steep discount — as much of the value is realised only at the structure’s conclusion. This is an important factor investors need to be comfortable with. 

Capital protection is another crucial point. Some products offer 100% capital protection over the term, while others include protection with T&Cs. For example, capital is protected as long as the underlying basket is not more than, say, 30% down at the end of the term. What matters here is the final date of the structure. It may trade lower than 30% down but recover by maturity, in which case the capital is returned.

Many also offer enhanced upside. For example, a 50% increase over the term will yield a 75% return for the investor. This, coupled with capital protection, is really at the heart of a structured product’s appeal.

However, the small print is once again key because some structures cap the upside potential, even if enhanced.

Others offer a direct payoff. For example, a positive close for the structure at the end of the term will yield a set return, regardless of what the underlying assets did.

Those underlying assets matter. I’ve seen structures based on everything from local and global indices to certain sectors, niche regional markets or even baskets of geographies. Make sure you understand and are happy with the underlying assets.

What’s even more important is that you’re taking balance sheet risk with a structured product. If the issuer or credit partner defaults, your capital is at risk, regardless of the structure’s terms.

One noteworthy wrinkle is that some are auto-call and may close earlier than the planned end date. This usually happens only if the structure is in the money, but it could shorten your longer-term plan, potentially by a few years.

Lastly, fees. These are typically +1% upfront, with ongoing annual fees. They are built into the structure’s profile, so even though you don’t see them, they exist.

The right structured product can be a great investment, just make sure you fully understand all the T&Cs before getting in.