Are you looking for an investment to diversify your portfolio? Structured products have a unique pricing model and can expose your portfolio to certain markets while mitigating some of the risks. They’re a bit complex and can be daunting for new investors, but they may be a beneficial addition to a portfolio.
How Do Structured Products Work?
A structured product takes one or more underlying assets and replaces their typical payment features with a nontraditional payoff. The underlying assets can include stocks, bonds, currencies and commodities. One of the most attractive features of structured products is their ability to make hard-to-reach asset classes available to retail investors.
Their pricing model is often similar to options pricing and other derivatives. Structured products can also be issued in a variety of forms, including debt-based securities like notes, certificates of deposits and closed-end funds. If it’s a structured product with principal protection, the investors are guaranteed to receive the amount invested when it matures, even if there are no gains. If the underlying asset does increase in value, the investor will receive a predetermined amount in returns based on the level of growth.
History Behind Structured Products
Structured products grew in popularity as a result of the rise in retail investors. They helped companies issue cheap debt to quickly raise funds. Structured products originated in the U.K. and Europe in the 1980s and quickly made their way to the U.S. in 1996.
Now, structured products are common investments that are listed with the Securities and Exchange Commission. They are just as easily accessible as stocks, bonds, exchange-traded funds (ETFs) and mutual funds. Plus, they make more inaccessible asset classes available to a wider range of investors.
Features of Structured Products
Structured products are popular for many reasons, especially their ability to be customized and principal protection. Many structured products have built-in principal protection, meaning no matter what the product’s value is at maturity, the investor will always get back the full amount they invested. More risk-tolerant investors may be able to forgo partial or full principal protection in exchange for a higher return rate.
Structured products are also a great way to diversify a portfolio and gain exposure to asset classes that may otherwise be hard to reach. Plus, investors may be able to bundle multiple asset types and classes into one structured product, creating a diverse investment to complement their portfolios.
Understanding Structured Product Terms
Investors need to understand a few key terms linked to structured products before investing. Here are a few:
- Barrier: A barrier note is a structured product that does not include principal protection. In exchange, investors may receive a higher return rate if the underlying asset is higher in value than it was when the note was issued.
- Strike price: This is the value or level when the structured product begins to provide positive returns. If the underlying asset’s value is higher than the strike price, the structured product will generate returns.
- Maturity: All structured products have set time frames. The maturity is when the investment period is over and returns are given, if applicable.
- Rainbow note: A rainbow note is a structured product that provides exposure to more than one underlying asset.
- Coupon: The coupon associated with a structured product guarantees that the investor will receive what they paid in principal back at the time of maturity.
Structured products are highly customizable, which means one structured product will not be the same as another. Ensure that you read all documentation associated with the vehicle before investing.
Benefits of Structured Products
Many retail investors find structured products attractive additions to their portfolios. Here are just a few reasons why:
- Potential for higher returns: Because of their nontraditional payoff model, investors may be able to get higher returns than just investing in the underlying asset. While the value of the underlying asset will rise and fall, investors will get a fixed return amount at the maturity date depending on the level of value of the underlying asset.
- Diversification: Structured products’ unique payoff model and the exposure they provide to other asset classes make them a great way to diversify a portfolio and mitigate risk.
- Customizable risk exposure: Structured products can also be tailored to the needs of your portfolio in regards to risk. If you choose a product with principal protection, you can rest assured that you’ll receive your investment amount back. If you have a higher risk tolerance, you can forgo the principal protection in exchange for the potential of higher returns.
- Access to hard-to-reach markets: Investing has become much more accessible to retail investors, but there are still some asset classes that are hard to gain exposure to. Structured products allow retail investors to access these markets, by purchasing a product with an underlying asset in those markets.
Risks Associated with Structured Products
- Liquidity: Structured products are not liquid investments. Once the investment is purchased, those funds cannot be accessed until the maturity date.
- Complexity: Despite their accessibility, structured products are one of the more complex investments to understand. They may not be a good fit for beginner investors who are still learning to navigate the markets and investment world.
- Market risk: The underlying asset that determines the value of the structured product is still tied to the market, so there is some level of market risk. If the market is doing poorly at the time of maturity, investors may not make any gains.
- Counterparty risk: Before purchasing a structured product, investors must vet the issuing institution. Structured products are a form of debt, and if the issuer cannot pay it off, investors may run the risk of losing that money. Investors should always check the issuing agency's credit rating and history.
Examples of Structured Products
Say a retail investor purchases a structured note in the form of a note for $500 with a three-year maturity. The structured product will contain a zero-coupon bond that guarantees the buyer will get their $500 back at the time of maturity and a call option on an underlying asset. During the investment period, the buyer will not receive interest payments or dividends. If the underlying asset has risen in value since the structured product was purchased, the buyer will receive a set amount in return.
Say the note determines that the investor will receive 3% in returns if the underlying asset achieves at least 5% in growth. If this level of growth was achieved, the investor would receive their original $500, as well as $15 in returns.
How to Choose the Right Structured Product
A variety of structured products track different assets and markets. Here are some tips on how to choose the best for your portfolio.
Identifying Investment Goals and Risk Tolerance
First, determine your goals and risk tolerance. If you want to save for a financial goal in the short term, you may not want to choose a structured product with a long maturity period. Additionally, if you don’t have a high risk tolerance, you may want to ensure you choose a product with principal protection.
Conducting Thorough Research on Different Products
Structured products vary in the markets they're attached to, maturity period and risk level. Ensure you thoroughly research a wide range of products and understand the fine print. Make sure the level of return aligns with your goals and that you trust the issuing agency.
Consulting with Financial Professionals
If you have questions about whether a structured product makes a good addition to your portfolio or what structured product to choose, contact a financial professional. They can give you personalized advice on which investments will help diversify your portfolio and help you achieve your goals.
Where to Buy Structured Products
Structured products can be purchased at most major financial institutions. Here are just a few that issue high-quality structured products.
Diverse and Accessible Investments
For a long time, most markets and investments were reserved only for the ultra-wealthy and institutional investors. However, with the rise of technology and innovative investment products, more markets are accessible to retail investors than ever. Structured products help bring hard-to-reach markets to a wide variety of investors to help them diversify their portfolios and achieve financial goals. For more guidance on choosing a structured product, contact your financial professional.
Frequently Asked Questions
How do structured products work?
Structured products track underlying assets, but use a similar pricing model to options trading. So if the underlying asset rises in value by the time of maturity, investors will receive a predetermined amount in returns.
Are structured products a good investment?
Structured products may make a good investment for investors who don’t need the liquidity and have the appropriate risk profile.
What are structured products examples?
Structured products can track a variety of underlying assets, such as bonds, indices and currencies. They also come in a variety of forms, such as notes, certificates of deposits and closed-end funds.
About Savannah Munholland
Savannah Munholland is an investment writer passionate about helping people learn more about accessible alternative investments. She has more than three years of writing experience, focusing on alternative and traditional investing, technology, and education. Her expertise in writing about art and wine investments is grounded in an MFA with knowledge of and immersion in a wide range of art-related topics. She uses her skills in creative writing to bring an appealing level of interest to her journalistic work, shifting even the most basic financial and investment topics from humdrum to compelling. Her work has been published on Benzinga, FreightWaves, and Study.com.