Financial Derivatives & Structured Products

Structured products offer an interesting option for alternative asset investors. They enable investors to invest in the performance of a range of funds with a relatively small minimum input and offer a useful tool for retail investors looking for easy access to derivatives.

Structured products were initially developed as a financial product in response to calls from businesses who wanted a system to allow them to issue debt more cheaply. From here, investment banks added additional features to a basic convertible bond to create the potential for investment strategies to be explored.

A key benefit for investors in structured products is the fact that it is possible to see a positive return even in a falling market. This is due to the high level of diversity within the funds and the nature of structured products themselves: there is no uniform definition of what they contain, they could a single security, a basket of securities or options, commodities, debt issuance, indices and foreign currencies.

Principal Protection

A bonus of structured products often cited is the fact that many of them will provide protection for the principal sum invested. This is relatively simple to guarantee by investing in standard low risk products with the majority of funds, while the remainder is invested as per the fund manager’s strategy to attempt to deliver as high a return as possible. Each structured product is, however, quite different and this protection cannot be taken for granted with all structured products.

Pros and Cons of Structured Products

A certain level of protection is important for some, but for many investors the main attraction of this alternative asset is the fact that it offers the ability to earn a positive return even in a flat equity market, with tax-efficient options and reduced volatility for those that wish to explore these areas.

On the downside, there is a certain level of credit risk given that the products are essentially unsecured debt from investment banks. In addition, these are highly complex products which won’t always appeal to the average investor and they are a particularly illiquid investment option as anyone looking to sell their product before maturity will see a major discount on their returns.

As with many alternative investments, structured products are a useful alternative investment for diversification. The option to protect the principal sum of investment makes them particularly popular with risk-averse investors, while still providing the potential to make a return, even in a falling market.