What is a structural product?

2.10.2022
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структурные продукты

Many investors probably have heard about this definition, but there are also those users who have not yet encountered it. What is it and what is it “eaten”with?

A structural product is a constructor that includes several financial instruments:

  • deposits;
  • bonds;
  • futures;
  • options.

All the listed instruments have different returns. What does it mean? On deposits, the remuneration is fixed, bonds are usually reported in advance, and futures and options are very unpredictable, sometimes everything depends simply on”luck”. Why this is so, we told you in this article.

The seller independently selects a set of tools that are part of the structural product, and determines the conditions under which it will be possible to make a profit.

Example:

By purchasing shares of the largest Russian companies, you expect to get a profit of 5-12% on the growth of their quotations. If this forecast comes true by the end of the contract, you will receive an income that exceeds the interest on deposits and bonds. If the forecast is not fulfilled, then you can stay with your money or lose a little.

The conditions under which you start counting on profit are also called an investment idea or strategy.

An investment idea is a fairly broad concept, since it includes several conditions.

Example:

The seller’s structural product consists of bonds issued by Rukan and Kirpik companies, and stock options issued by Vafli and Sok enterprises. The seller expects that the stock market will not experience strong fluctuations in stock prices, and will also be relatively stable. After 3 months, the investor can receive a return of 20% on the investment, if the following conditions are met.

  • during this period, the companies “Rukan” and “Brick” must not default on the bonds, fulfill all obligations under them, including the payment of coupon income;
  • the stock prices of the companies “Wafers” and “Juice” will not change, that is, they will not rise in price or fall in price by more than 10%.

If one of the conditions is not met, then the seller will not earn anything and will remain with “his”, that is, he will receive the same amount that he originally paid. Such an offer will be profitable only if the stock market remains in “place” and there are no prerequisites that predict its growth in the next 3 months. If you only buy stocks or bonds, then you will not get a 20% return, and this is the “strength” of structural products.

Financial risks

structural products with capital protection

Any investment products are accompanied by risks. When it comes to risks of structural products, it should be noted that they directly depend on the degree of capital protection:

Currently, there are structural products with the following degrees of protection::

  • full. Usually, the yield on them is not so high, their strong point is that the seller of the product will return all the invested funds, even if the investment idea is not fulfilled. However, they may not generate any revenue. This category is usually chosen by cautious investors (read more about it here);
  • conditional version. The investor will be able to receive the full amount of investment only if all the conditions of the strategies are met.

Example:

  • Let’s say an investor bought a structural product with payouts linked to the stock prices of one Waffle company. If the share price of this company does not fall or falls, but only slightly, within 15%, then the investor can expect a 20% return. If the quote decreases by 15-30%, then he will receive only 60% of the investment amount. In cases where the drop exceeds 30%, the investor will be issued shares of the company for the entire amount. In this case, the share price will be taken at the time of purchase of the product. In other words, the buyer will go back a year and buy the Waffle stock, not the structural product. If the stock price falls by 40%, the investor’s losses will amount to 40%. This solution is more suitable for investors who are willing to take risks for the sake of big benefits.;
  • without protection. Such products usually do not have maturities on a specific date. Purchase / sale can be made at any time, and the result of the transaction will depend on fluctuations in the price of the product. The price of such structural products is usually linked to the underlying asset, usually the exchange index is taken as the equivalent. In some ways, this option is similar to the units of exchange-traded funds. Changes in the price of a structural product may exceed fluctuations in the index. For example, if the index drops by 10%, the price of the product may decrease by 20%. If the index rises by 10%, the price of the product will increase by 20%. This option is only suitable for experienced investors who have extensive experience in predicting the movement of indices and can quickly make decisions regarding the purchase/sale of products.

Thus, a structural product that has full capital protection is considered less risky than the acquisition of shares. Full protection means that the investor will be able to return the funds in any case, regardless of the situation on the stock market. Of course, you may not get any income if the idea doesn’t work out, but at least you’ll stick with your own ideas. What does it mean?

For example, if you buy shares in the companies Wafli and Sok, and they fall in price, then you will naturally lose some of your capital. Under the terms of the full protection product package, which includes these shares, you simply will not receive any income or losses on them.

Structural products with and without conditional capital protection are considered riskier than the acquisition of real assets. As a rule, losses on them often exceed those that would have occurred if stock prices had declined.

In cases when the investment idea of such products does not come true, the investor may lose money even if the stock market will increase the price of assets.

Example: it is planned that the shares of the companies “Wafers” and “Juice” will rise in price by 15%, and under the terms of the idea, the growth should not be more than 10%. Investing in a joint venture in this situation is unprofitable, which means that you will not get any income. If you just bought ordinary securities, you would be able to earn good money due to the growth of stock prices and coupon income on bonds.

Structural products also include conditions such as:

  • currency appreciation / depreciation at certain intervals;
  • fluctuations in precious metal prices;
  • changes in stock indexes.

What are the different varieties?

structural investment products

Currently, there are two types::

  • structured transactions;
  • structural securities.

Have you ever entered into a contract with a bank, brokerage or insurance company, or a trustee? As a rule, contracts with these organizations contain conditions under which you can receive income or loss. Like any civil law document, the contract has a certain period of validity. If the contract is terminated prematurely, you may get back less money than you invested. These are structured transactions. Structured transactions include structured deposits and transactions with a portfolio of bonds.

The yield or unprofitability of a security is usually fixed in the terms of issue. Theoretically, the holder of a security can sell it at any time, but the buyer is not as fast as we would like. Structured securities are divided into structured notes and structured bonds.

Structural deposits are usually offered by banking institutions, also known as investment or indexed deposits.

The bank offers the client to open a deposit that has a fixed income. Remuneration for it is given in advance, but not on the “hands”, but they invest them in PFI futures or options. If the investment strategy of the bank is fulfilled, the client will become the owner of a large income, which will exceed the interest on the deposit. If the idea fails, the depositor will receive back only the deposit without interest.

Example:

The bank offers to invest 100 thousand hryvnias in a structural deposit for 12 months at 8% per annum. This means that at the end of the deposit term, the client would have received a reward in the amount of UAH 8 thousand. For this amount, the bank sells the client an option to purchase shares in the company “Wafli”.

The investment strategy assumes that in a year the company’s shares will grow in price by no more than 20%, which will give the client a profit of 15 thousand hryvnias. This means that you will be able to earn more than on a regular deposit. If the shares fall or increase in price by more than 20%, you will only be left with your 100 thousand hryvnias in a year.

As a rule, the bank offers its clients a PFI for the purchase of a liquid asset that can be quickly sold at market value on the stock exchange. These can be shares of large domestic or foreign companies, shares of exchange-traded funds, etc.

Structural deposits are also offered by insurance companies and trust managers.

When choosing a structured financial product, it should be taken into account that the interest-free amount of the bank’s deposit is insured by the state, unlike the deposit opened by companies. If the bank’s license is revoked, you will be able to return the deposit within the limits set by the state.

The structural bond is offered by individual life insurance companies, as well as brokerage companies and trust managers. However, keep in mind that the funds you want to invest in their products are not protected by the deposit insurance system. In addition, the risk of losing funds is fixed in the conditions of most structured transactions.

The insurance company does not promise income on ICI policies, but usually prescribes in the contract the condition that in any case, you will receive the deposit amount back, even if the investment fails.

If a structured transaction was concluded with a brokerage company or trustee, then you will need to decide on the amount that you can donate. The risk can be equal to 0% or 100% of the investment.

Zero-rate risk means that you will get back as much money as you put in the account of a brokerage company or trustee. It turns out that these are transactions with full capital protection. The higher the risk score, the greater the share of money you are willing to part with. For example, a 20% risk means that you are ready to lose up to 20% of your investment. This transaction will have partial protection. And accordingly, 100% risk is 100% loss in a bad scenario. Let’s take a look at what this will look like in real life.

Example:

The broker offers you to participate in a structured transaction with a validity period of 1 year. The essence of the broker’s investment strategy is that fluctuations in the S&P 500 stock index in one direction or another will not exceed 15%. Accordingly, you make a contribution to the brokerage account in the amount of 100 thousand hryvnias and thus conclude a structured transaction with the brokerage company that has full capital protection. Next, you give the broker 2 tasks – buy a fixed-yield bond portfolio and buy / sell options or futures. Due to the fact that you have full capital protection, the broker will buy corporate bonds of large domestic and foreign companies for 90 thousand hryvnias, and spend the remaining funds on futures and options.

If the broker’s investment idea is justified, then you will receive about 20% per annum, which means that in a year the broker will give you 120 thousand hryvnias. If the forecast does not come true, you will receive your 100 thousand hryvnias. If there are losses on futures or options, the broker will cover them using the income received from the bonds.

The broker will offer you a higher return if you prefer partial capital protection or no capital protection. For example, a broker offers an income of 40% per annum with 50% capital protection. If the investment strategy is executed, you will receive a 40% profit, but if not, you will lose half of the initial deposit.

According to the law, only banks, brokerage and dealer companies, as well as specialized financial companies can issue structural bonds. Structural bonds are coupon securities that have conditional capital protection. In other words, the issuing company may pay you the full face value or part of it, or give you nothing at all, at the end of the term. The amount of payments is fixed in the terms of the issue.

Fixed or variable coupon income can be accrued on structural bonds. For a fixed coupon, the amount of income is known in advance. The coupon may have a lot of income, but you will only be able to get it if the strategy comes true. Otherwise, you can expect a symbolic reward of 0.01%. As a rule, this income does not cover the commission that the broker or management company will charge for their services. However, in this case, the company that issued the bonds will pay an additional variable income. The amount of variable income is often linked to one of the exchange’s indicators. It can be the S&P 500 index or the Moscow Exchange index. The size of the coupon is also affected by fluctuations in the exchange rate or the price of the product.

The amount of income on a variable coupon exceeds 2-3 times the income on classic bonds. Structural bonds can be purchased through a broker or trustee, and the services of the former are much cheaper.

Unlike bank deposits, bonds are not protected by a deposit insurance system. If the bank loses its license, the depositor will have to wait quite a long time for the payment of their funds, since the bankruptcy procedure takes a very long time.

Structural notes are securities issued by Western investment banks. To purchase them, you need intermediaries – brokers or trust managers. Structural notes are very similar to bonds. Traditionally, they have a certain validity period, and at the end of this period, issuers pay holders the face value of the note. In addition, the holder may receive certain payments at the end of the note’s life or several times during its life.

The yield on a structured note depends directly on the price of a particular underlying asset. The underlying asset can be a company’s shares, precious metals, oil, or a stock index.

The binding of a security note can be absolutely any. For example, a bank promises to pay income if the value of the underlying asset falls, does not grow, or is completely within the agreed price corridor. If this condition is violated, the bank will pay the investor only a part of the nominal value of the security.

Example:

The yield of a structured note depends on the price fluctuations of the Omega IT company. If the price of Omega shares does not rise or fall by more than 10% during the year, the investor will receive a 20% return at the end of the note’s validity. If the price change is greater than in the condition, the buyer of the note will receive only 60% of the investment.

If you know for sure that Omega shares have stable quotes, then there is no point in buying them, since the opportunity to earn money on them is zero. However, buying a note, on the contrary, will be very profitable. If your expectations do not come true and the price of them suddenly increases by more than 10%, then you will lose about 40% of your investment.

Structured notes are an even riskier instrument for domestic investors than structured bonds issued by domestic issuers. This is explained by the fact that in case of bankruptcy of a foreign issuing bank, you will have to follow the laws of the country where the bank was registered. This means that it will not be easy to get your money back.

What are the risks associated with buying a structured investment product?

investing in structured products

Investing in structured products may involve the following risks::

  • loss of projected revenue.You can invest in the underlying assets or in the structural product that is associated with them.In this situation, it is impossible to say unequivocally which investments will bring more profit and whether they will be profitable at all.There is always the possibility that by purchasing a structured product, you may lose some of the income and be left without what the purchase of the underlying asset could have provided.;
  • market type.The yield of any joint venture is affected by changes in the market value of the underlying asset.If JVs with full protection give you a chance to save your savings, then JVs with or without conditional protection can bring you unpredictable losses;
  • illiquidity.As a rule, it is not profitable to terminate structured transactions prematurely, because this way you will lose most of your investments.The amount of losses is usually fixed in the terms of the transaction.In most cases, purchased structural securities can only be sold to the broker or trustee from whom you purchased them.The terms of the contract usually specify that they are not required to redeem them from the holder before the specified deadline.Some structural securities are traded on the stock exchange, where they can be sold long before maturity, but in this case their price may be lower than the one at which you purchased them.As a result, you will not get the expected income, but unexpected losses;
  • default on bonds, non-repayment of deposits.Typically, structural products consist of bonds issued by reliable companies or deposits from stable banks.Thanks to this composition, the risk of losing funds in the event of a fall in the quotes of other instruments is reduced.If the company that issued the bonds or the bank that opened the deposit goes bankrupt, you will suffer heavy losses.This risk is very small, but before you buy a joint venture, carefully and seriously study its composition;
  • bankruptcy of a financial institution that created a structural product.This type of risk is considered the biggest of the listed ones, because in the event of bankruptcy of the company that issued the joint venture or the one with which you concluded the transaction, it will be extremely difficult to return the funds.You will have to wait for the long bankruptcy process to end.Of course, you should not expect a refund of the full amount, most likely, you will receive some part of the deposit.

Thus, structural products are accompanied by high risks. If you hear somewhere that a structural product is the same deposit or bond, only much more profitable, do not believe it, because this statement does not correspond to reality.

What opportunities do structural investment products offer?

Despite all possible risks, in most cases JVs are still considered more profitable and less risky investment instruments. You will only win in the following situations::

  • there will be no growth in the stock market, which means that stock prices are at the same level or gradually decrease.If you meet these conditions, you will receive income from direct investment in stocks.Sellers of structural products need to come up with an idea that will allow them to make money on futures and options in a frozen or falling market;
  • usually, foreign securities with high yields are very expensive, their price can reach tens or even hundreds of thousands of euros or dollars.Only a few people can buy them.However, with a small amount of capital, you can invest in a structural product linked to the portfolio of these securities;
  • do you want to make a profit that will exceed the remuneration on deposits and bonds, and at the same time do not want to lose money?A joint venture with capital protection will reduce the investment risk.However, a reliable seller of structural products is suitable for this transaction, it can be a banking institution, an insurer, a brokerage or a management company.When choosing a seller, pay attention to the size of assets and their age.Also, information about the ultimate beneficiaries of the company will not be superfluous.This information is usually published on the company’s website.

JVs can generate more income than on stocks, bonds, and deposits at the expense of mutual funds. Large players have more favorable terms for them, while private investors have less. This means that if you want to build a constructor from tools yourself, the profit on them will be much lower.

Who can buy structural financial products?

Prices for joint ventures are very diverse. For example, the value of a Russian structural bond can reach up to 1 thousand rubles, and a foreign structural note starts from 1 thousand dollars. As a rule, the average transaction amount starts from several tens of thousands of rubles.

Do not forget that in addition to the cost of the structural product, you will have to pay a commission to the seller – broker or management company. The commission amount is usually announced when purchasing a structured security.

In structural transactions, the commission is usually hidden. The seller invests his profit in the parameters of the joint venture. How to understand? Under the terms of the deal with the broker, if the strategy is executed, the investor will receive 20% of the deposit income. But in reality, the income can be much higher, for example, 30-40%. The difference between the real income and the one you will receive is the seller’s hidden commission. You will hardly ever be able to find out the broker’s profit.

Working with structural products is most suitable for qualified investors who meet the criteria set by the country’s central bank. For example, he has 6 million rubles on his account or a certificate of a financial specialist. Structural products are very complex, and only experienced investors will be able to work with them.

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