Structured Products! What a complex name, isn’t it? No matter what your first thoughts might have been on reading this term, it is one of the most exciting investment options available to investors. Structured products in India have been present since 2007-08. In the following analysis, we have discussed everything our readers would like to know about the structured products in easier language. Let’s read on!
In This Article
1. Structured products
- What are Structured Products?
- What are the Components of Structured Products?
- How does a Structured Product Work?
- What are the features of Structured Products?
- Types of Structured Products
2. Structured Debt
Investment instruments with a majority bond component as well as equity and derivative products. Hybrid in nature and specially designed to suit a client’s goals and risk appetite. Structured products differ from other products. It combines two or more asset classes (conventional asset classes like stocks, bonds, etc. with derivative products like Forwards, Futures, etc.) to meet an investor's needs.
It is easily customizable and can offer great diversification of portfolio to the investors.
Structured products typically comprise bonds, equities, and derivatives as an underlying asset class. Moreover, these products can come either with Capital protection(full or partial principal return) or without capital protection feature.
Clearly, as is evident, the goal is to increase the investor's returns by investing in popular instruments like stocks and bonds. Derivatives are also a part of the portfolio. This balances the overall risks, especially in a bad market. When underlying security provides value to an instrument, they are termed as derivatives. For example, a gold futures contract derives its value from gold).
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Structured products with a combination of bonds and derivatives are highly popular in India.
1. Bond: The bond component provides capital preservation as the issuer of the bond promises to return the capital. It thus gives a source of income and stability.
2. Equity: It will thus enhance investment. Generally, there is one equity or a set of stocks and selected ETF which follows a particular index like Nifty or Sensex, currency, etc.
3. Derivative: It balances the overall risks involved. It is related to the risk tolerance of the investor. Examples are Futures, Forward, Swap, etc.
Structured products comprise traditional instruments like bonds but the whole package is designed in such a way that the normal returns from bonds are substituted by underlying assets like derivatives etc.
Let’s understand the working of a structured product with an example,
Suppose you have invested Rs 1000 in a structured product. It has a capital preservation feature of 5 years. Subsequently, you would be getting your initial invested amount(Rs 1000) after maturity (on completing the 5 year period) in addition to the returns generated by the underlying assets.
Thus, in this case, Rs 800 will be invested in bonds whose maturity value would be up to Rs 1000 (after 5 years). This is because the fund manager is bound to preserve your capital and consequently invests in fixed coupon debentures.
Debentures are money borrowed by the companies on the promise of repayment with interest. They offer coupons to the investors called coupon debentures.
Lastly, the final returns on the structured products in India would depend on the performance of the index. In case the performance is positive, there would a total returns plus capital. If the performance is negative in contrast, only capital will be returned.
1. Ensures Capital Protection: One of the most important features of structured products. Investors who are risk-averse can avail of this product. This helps is preserving the invested capital regardless of the market situation. All investors can avail of this option.
2. Potential for Great Returns: In addition to capital protection, structured products also have the potential to deliver attractive returns as they follow the performance of the index.
3. Flexible: Structured products are highly customizable. This thus helps the investors to take a 2 or 3-year view of the market and monetize their gains.
4. Efficient Taxation: Owing to the highly attractive taxation features, structured products have caught the attention of High Net-worth investors as well as institutional investors. If the returns held for more than 36 months, a long-term capital gain of 10% and the surcharge is levied. However, given the complexity of these products, it is advisable to consult a tax expert before opting for these instruments.
5. Hybrid portfolio: A good mix of two or more asset classes in addition to traditional and non-traditional instruments thus offers appropriate diversification.
Private banks, Wealth management firms, and NBFC (Non-Banking Financial Companies) offer structured products in India. It is typically suited for high net-worth investors who are looking for low risk and portfolio diversification for good returns. In India, Edelweiss Wealth Management Ltd. and Kotak Securities popularly deal in structured products, as per CARE Ratings.
Following features are present in such products,
1. Combination of Assets: It is important to remember that these products are hybrid in nature. They comprise a large component of bonds for capital preservation as well as equity and derivatives for capital growth and income. When the structured products are composed perfectly, they thus ensure returns with minimizing risks.
2. Amount: The approximate ticket size for structured products may vary across various issuing authorities. High Net-Worth investors in India are well suited for these products and the ticket size is Rs 25 lakhs. Subsequently, these investments are done through PMS(Portfolio Management Services) and the stated guidelines are followed.
3. The Risk-Return principle: The composition of the products defines the risk involved. Since it is customizable, it perfectly suits an aggressive investor as well as a conservative investor. As the structured products follow an index, the returns generally range in CAGR 10% or 25%, subject to market conditions and certain other factors.
4. Duration: Generally, structured products come with a fixed maturity period during which an investor has to stay invested. In India, it ranges from 1 year to 3 years.
5. Professional handled: Highly efficiently managed by the banks and wealth managers. Helps to meet the goals of the investor and also minimize the risks involved. Structured products ensure that they meet the requirement even during a bad market phase.
|Conservative Structured Products||Aggressive Structured Products|
|These products consequently come with a Capital Protection feature. Also, the upside participation in this is lower.||These products don’t come with a Capital Protection feature. Also, the upside participation in this product is subsequently higher.|
|For example, an investor has invested in a conservative structured product with upside participation of 120%. |
Also, 120% upside participation means that if the index increases 10%, the investor would get a 12% return.
|For example, an investor has invested in an aggressive structured product with upside participation of 200%. In case, the market falls down, the investor would also lose the capital. The returns would again be subject to the index performance.|
It is a type of debt that a lender has designed to meet the specific needs of a borrower. Such a debt package has incentives for the lender to encourage them to do business with the borrowers. Moreover, one of the best examples of a structured debt is a mortgage.
In such a mortgage there is a flexibility to switch between fixed and variable interest rates. This would allow a borrower to begin the mortgage at a competitive rate and later shift to a variable rate. This will ultimately help them take advantage of any drop in average interest rate. It will reduce the amount of debt they have to return over the mortgage.
In addition to the above, many other incentives can be included in the agreement. Extending the grace period for balloon payment can be one of the options. This option can be highly helpful for business which has suffered a loss and is rebuilding itself and is not yet in a comfortable position to repay.
Another option can be to defer interest payments until the end of loan. This would allow the borrower maximum time before they can pay back to the lender. It will increase the chances for the borrower for their project to get funded from the collections from the bonds sold. The revenue generated from such a project would be able to cover the principal as well as the interest.
Based on the degree of principal at risk as the foremost criteria and the type of return and participation as a secondary criterion, four types of structured debt securities can be mentioned, which are,
1. Capital protected product: These products ensure that the capital which the investor has initially put in, stays safe. Investors have to give a portion of their equity appreciation in return for their capital protection.
2. Leveraged product: They have a high risk in comparison to the initial investment and combines an investment with a future or option.
3. Yield enhanced product: These products are designed to produce maximum return on the investment. However, the principal is only partially protected, buffered or at huge risk. They have a degree of risk if the investment falls below the buffer zone.
4. Participation products: Based on the various underlying securities, these products derive their value.
Structured products are a combination of two or more asset classes like equity, bonds with derivatives like futures, forward, swap, etc. High Net-worth investors can avail of this instrument from a private bank or a wealth management firm, with a minimum ticket size of Rs 25 lakhs.
It has lots of benefits like Capital protection, flexibility, professionally managed among others. It helps in minimizing the stock market risk for investors who wish to diversify and also get good returns. 10% LTCG for products held for more than 36 months is levied on this instrument. It is thus advisable to consult your tax adviser before investing in these products.
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