Structured products: better than their reputation suggests

Making Innovative Investments – Structured Products Open Up New Options

Low interest rates and high equity valuations cause investors to look for suitable alternatives. Structured products offer variable investment opportunities in order to be able to take advantage of return opportunities even in the current market environment. What you should know about the topic.

In recent years, structured products have increasingly established themselves as investment instruments. In October 2017, there was a total value of CHF 200 billion in structured products in clients' safekeeping accounts at banks in Switzerland and Liechtenstein, according to a survey carried out by the Swiss National Bank. This corresponds to about 5 percent of all of the assets managed in Switzerland.

They have not been traded in Switzerland for very long, however. The first time a Swiss bank launched a structured product was in 1991, but they have a much older origin than that. The first comparable transactions can be traced back to 1700 BC. Then, derivatives were used by agricultural producers to hedge against falling prices. At the same time, buyers were able to protect themselves against increasing prices. Such forward transactions became acceptable in the 19th century with the introduction of uniform standards for traders.

Invest in Structured Products

Nowadays, structured products are often vilified (mostly falsely) as being speculative. Contrary to widespread belief, they are not only suitable for investors who are willing to take on high risk, but also for cautious investors looking at the wide range of products for suitable alternatives to traditional investment products. Depending on the type of structured product, the spectrum ranges from conservative investments with low risk of loss to strategies with very high risk that promise high returns in the event of success.

By using structured products, the risk/return ratio of a portfolio can be increased significantly. Here, investors are spoiled for choice: On one side, there are countless derivatives to choose from in the market. On the other, investors can develop structured products themselves and adjust them perfectly to their desires and needs, be it respective to the risk profile or to their own expectations for the financial markets.

Derivative Financial Products Are Innovative

Even with sideways-moving markets or falling market prices, investors can achieve profits with structured products, depending on the scenario they set. Because choosing underlying assets opens up a lot of options, it even allows for investing in markets that are otherwise difficult to access. There is hardly another product class that is more suitable for portfolio diversification.

Many investors bet on structured derivatives (e.g. BRCs) to realize returns in the form of a fixed coupon, even with sideways-moving markets. Additionally, incorporating a risk buffer – mostly conditionally – provides additional protection.

Conversely, the payout profile can be designed with greater risk tolerance so that investors are able to benefit disproportionately from a growth of the underlying asset. Structured derivatives are often even possible with low usage so that investors can invest in a diversified manner with a small budget.

Prejudices against Structured Products Remain

Despite the advantages described above, structured products have been subject to prejudices since the financial crisis: too costly, too obscure, too little return. The costs associated with them are generally comparable with investing in traditional investment funds. The investment formula determines success or failure. The investor is therefore not at the mercy of the fund manager's decisions. A study carried out on behalf of the Swiss Structured Products Association (SSPA) showed that structured products performed positively in the period under review compared to costs. Under normal market conditions, they generated a return of 5 to 15 percent per year.

There is no return without risk. As with all securities, there are also risks when investing in derivative financial investments. The worst-case scenario is that the investor will lose all of the money he/she has invested. This is the case if the expected scenario is not achieved or the issuer of the structured product has to file for insolvency. Investors can only partially protect themselves from issuer risk by buying products from trusted financial institutions. Furthermore, capital protection certificates allow for hedging invested capital against market risks. When used properly, structured financial products offer suitable solutions for every investor (or every risk profile) in order to realize their own market expectations efficiently.