Structured Products: Balancing Risk And Reward

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Grip
Grip
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Aug 10, 2023
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    Structured Products-Balancing Risk And Reward

    In recent years, Structured Products have become popular for investors as they seek various opportunities to diversify their portfolios. But what are structured products?

    As per the SEBI Circular, Structured Products are a variety of hybrid securities that combine features of plain vanilla debt securities and exchange-traded derivatives issued through private placements and listed on stock exchanges. They are hybrid investment vehicles created by bundling multiple financial assets with exchange-traded derivatives, such as stocks, bonds, commodities, or other assets. Since such returns are linked to equity markets, these instruments are known as equity-linked debentures, stock-linked debentures, or market-linked debentures (MLDs).

    How Do Structured Products Work?

    Structured Products are instruments tied to an index or basket of securities. They are designed to facilitate customised risk-return objectives. The issuer attains this objective by taking a traditional security such as a G-Sec bond and replacing the coupon payments and final principal amount with non-traditional payoffs derived from the performance of underlying assets.

    As per the SEBI circular, securities that do not promise return and protection of the full principal amount at the time of instrument maturity will not be eligible for issue and listing under the said regulations.

    Structured Products are issued with market-linked returns obtained through exposures on underlying assets (as per SEBI’s operational circular), some of which are as under:

    • Securities
    • Index
    • Commodity
    • G-Sec
    • MIBOR (Mumbai Interbank Offer Rate)
    • MCLR (Bank Marginal Cost of Fund-based Lending Rate)
    • Exchange-traded derivatives
    • GDP
    • Inflation Rate

    Understanding Structured Products Better

    Let us take an example to understand how a Structured Product works. The following are the assumptions for ease of understanding:

    • Invested amount = INR 10,00,000
    • A simple interest rate of 8%
    • Invested for three years
    • Invested in Nifty 50 linked Structured Product
    • Assuming Nil roll-over cost for the Derivatives

    The issuer will put INR 806,500 in Fixed Deposit, earning an annual interest of INR 64,520, totaling INR 193,650 at the end of 3 years. This will ensure principal protection of INR 10,00,000 (INR 806,500 + INR 193,650 earned as Interest).

    A balance of INR 193,500 will be invested in Nifty Future. Assuming a 35% growth in Nifty at the end of 3 years, it will generate INR 67,725. Thereby the total amount generated will be INR 261,225 from Nifty Investment.

    At the end of the third year, the initial investment of INR 10,00,000 will be INR 12,61,225. After deducting the issuer fees and charges, the Investor will get returns which will be higher compared to Fixed Deposits.

    Even if Nifty has fallen 20% at the end of the third year, the investment of INR 193,500 will become INR 154,800, whereby the investor will get a total of INR 11,54,800 at the end of the third year. 

    This is a simple arrangement. With the use of hedging like Nifty Options, where the issuer gets margin leverage, the returns can be multi-fold.

    Features And Components Of Structured Products

    Structured Products consist of various features and components, including:

    Underlying Assets: The underlying asset that forms the basis of the product's performance.

    Bonds: The bond component in the Structured Products provides capital preservation as the issuer promises to return the capital.

    Derivative Instruments: Use of derivatives like Futures, Options, Swaps, etc., to create a desired risk-return profile based on the risk tolerance of the investor.

    Benefits Of Investing In Structured Products

    Investing in structured products can offer a range of benefits not provided by traditional investment options. They are pre-packaged products designed to meet specific investment objectives and offer significantly higher returns per investors' risk appetite. Some of the benefits are as below:

    Highly Customisable: Structured Products are customisable per the investor's risk appetite.

    Investor’s Growth Objectives: Structured Products are tailor-made to achieve an individual’s growth objectives.

    Monetize Market Views: Investors have the flexibility to customise the product to benefit from personal market views. 

    Capital Protection: Only Capital Protected Structured Products are allowed in India, safeguarding investors against any downside risk of capital erosion.

    Gains in Bear Run: Investors can gain even in a bearish market with derivative options like puts or short sells.

    Diversification: Structured Products, hybrid instruments, combine two or more asset classes, generally traditional and non-traditional. By combining two different underlying assets, structured products offer diversification benefits, reducing the impact of individual asset performance on the overall investment.

    Risks Involved With Structured Products

    Some of the inherent risks involved with investing in Structured Products are as under:

    Market Risk: Fluctuations in the underlying asset prices can impact the product's performance.

    Complexity Risk: The intricate structures of some structured products may make them difficult to understand, increasing the risk of making uninformed investment decisions.

    Liquidity Risk: Limited secondary market liquidity may restrict investors' ability to buy or sell the product.

    Counterparty Risk: This arises when the issuer or other parties involved in the structured product fail to fulfill their obligations.

    Zero Return Risk: If the investor gets back only the principal amount, there is a notional loss of interest. If deployed in other instruments like fixed deposits, this money would have given better returns.

    Key Considerations When Evaluating Structured Products

    While evaluating structured products, it is important to consider below mentioned factors:

    Product Suitability: Assessing whether the structured product aligns with your investment goals and expected returns.

    Issuer Creditworthiness: Evaluating the financial strength and credibility of the issuer to ensure the return of capital and returns as promised.

    Historical Performance: Analysing the past performance and track record of similarly structured products.

    Transparency: Understanding the product's structure, fees, and costs.

    Conclusion

    Structured Products offer great diversification investment opportunities but require careful evaluation and consideration of risks and benefits. Investors can make an informed decision by understanding the features and risks involved and striking a risk-reward balance in their investment portfolios. It is advisable to seek advice from a qualified financial professional or use Grip Invest as an investment discovery platform that provides alternative investment opportunities starting with a minimum of INR 10,000. Explore Grip’s LeaseX and LoanX products which securitize cashflows from various underlying assets to provide a high-yielding fixed-income instrument. 


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    Disclaimer: This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip Invest Technologies Private Limited ("Grip", formerly known as Grip Invest Advisors Private Limited) is not registered with SEBI in any capacity and does not advise, encourage, or discourage its users to invest or not invest in any securities. Grip is solely an execution-only platform and does not guarantee or assure any return on investments made by you in any opportunities sourced by Grip and accepts no liability for consequences of any actions taken based on the information provided. Your investment is solely based on your judgement. Investments in debt securities are subject to risks. Read all the offer-related documents carefully.

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