What are structured products and how do they work

Many a times, investors have to deal with a market that is fraught with uncertainty and high volatility. During such times, many hesitate to invest even if they may be willing to do so, for fear of losing all their capital. Structured products have been a successful avenue for many under such circumstances, providing not only an efficient mode of investment across asset classes but also a tailored capital protection option, without compromising on returns.

Structured products are investment solutions created to adapt to the needs of the investor – such as risk and return profile, liquidity requirements, and the amount to be invested – while also enabling a wide range of asset classes for investing with options for redemption. Therefore, structured products provide tailor-made solutions in line with a specific strategy for all market configurations and are sophisticated in nature.

Structured products combine one or more asset classes to create a non-traditional investment strategy to suit the specific needs of the investor. A typical structured product includes:

  • A bond
  • One or more underlying assets such as equities
  • A derivative of the underlying asset

The bond component helps in providing capital protection from the issuer of the bond. In case of non-capital protection oriented products, they provide a stable, additional income.

The underlying asset helps generate the return component. For instance, let us consider a product that seeks to return the initial investment plus a certain extra income, linked to Nifty Index, over a 5 year period. For an investment of Rs 100 in such a product, Rs 90 will be used to invest in instruments that can help in returning the initial investment after ‘lock-in of 5 years’ ;  while Rs 10 will be used to invest in riskier financial instruments that can provide higher than Nifty Index returns.

The derivatives component is a crucial component to help determine the overall returns of the investment product. Options are more commonly used than futures, depending on the leverage and risk-tolerance levels in the portfolio.

Thus, structured products provide an integrated, tailor-made, packaged financial investment solution that also helps in diversifying the existing portfolio of investments apart from providing capital protection without compromising on returns. The product’s flexibility allows for stability and makes positive returns even in a downward market environment.

These products are offered by wealth management firms and private banking teams to high net-worth individuals or corporate investors who typically want to maximise the chances of achieving their target returns along with customised professional investment advice and guidance.

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