Every decade brings in its own fads. This holds true for the financial sector too. Prior to the global financial crisis, who had heard of collateralised debt obligation, leveraged buyout and other terminologies and many exciting ways and means of making money swifter and faster? As long as greed and fear remains, human ingenuity will play on these to get more and more money.
In the light of this, let us understand how structured products, with the intention to protect capital, are finding increasing acceptance. Investments are usually never bought. Typically, they are sold, and if not pushed by persistence, bought on peer pressure. With increasing volatility and acting on the fear psychosis, capital protection is the new mantra. Investors want definitive returns and look at returns that can be earned with stability. Though bank fixed deposits fit into the above definition, the post-tax return reduces their sheen.
This is where structured products come into the picture. A structured products is broadly defined as the one that invests in hybrid investments, in multiple asset classes, as per the prevailing market sentiment, which at times also has capital protection as one of its key features. It works similar to a close-ended mutual fund scheme. Such products can either have the feature of capital protection or formula-based returns.
In a capital protection product, the investor is assured of receiving back his original investment on maturity. The point to note is that this is assured only if the investor holds the investment till maturity. In formula-based returns, the product is tailored as per the market outlook, as determined by the fund manager.
In India, index-linked debentures that combine the low risk profile of a debt product and the high returns of equities is quite popular among high net-worth individuals. Of late, to capture the retail appetite, mutual funds have also started capital protection funds. Now the question is, should you invest in this product? The golden rule of investment is: Invest with a goal, which has time horizon, is in line with your risk profile and matches your liquidity needs. If the product fulfils these criteria, then one should consider it.
After this stage, one should also consider the transparency of the product, the tax implications, cost and fees structure, liquidity of the product, risk to principal and return, and above all the creditworthiness of the issuer and the past track record. Most importantly, one should be able to understand the product and the advisor should be able to explain in a layman?s language and clear all your doubts.
A structured product is a passive investment strategy for investors. It is marketed usually during a bull run, feeding on the fear and greed phenomenon. It works on the principle of asset allocation, the control of which rests with the fund manager. Moreover, it has a specific term (which many a times does not allow investors to take advantage of market situations). How does it work?
Say, you invest R10 lakh for three years with a mandate to the issuer to invest anywhere between 81% and 100% in debt and 0-19% in equity. The issuer will, in turn, according to the prevailing interest rate, invest that portion of the corpus in debt instruments in a tenure that corresponds with the redemption period, and the rest in equity or any other asset class, which will then generate the alpha returns. So the capital is protected at all times.
One needs to understand that if the call of the fund manager in investing in the asset class goes wrong, only the capital that you had invested can be redeemed, which is a negative return in real terms. Alternatively, you can set your own capital protection structure with liquidity in your hands. You can save on the charges paid to the issuer, enjoy easier liquidity and have control of the investment in your hands.
As in any other investment product, structured product have their advantages as well as disadvantages. Do understand the product and do not invest on peer pressure or persistence of your relationship manager. Goal-based investing based on asset allocation are the pillars and make volatility in the markets your friend.
The writer is founder and managing partner, Zeus WealthWays