As with any form of investment, there are risks associated with structured products. Below is a summary of the risks, and potential disadvantages that an investor should bear in mind before considering an investment in a structured product.
Market RiskFor structured products whose return is linked to the performance of an underlying stock, index, commodity or other asset class, the performance of the structured product will be determined by the performance of these underlying asset classes, depending on the structure of the product in question. Thus the investor is still taking a predefined level of market risk with a structured product.
Counterparty RiskThe majority of structured products on the market contain some form of capital guarantee or other form of protection, which is backed by a bank. If that bank or financial institution should go bankrupt, insolvent, or otherwise face difficulties in meeting it’s obligations, then there is a risk that you may not get back all of your initial capital investment.
Restricted Access to CapitalThe vast majority of structured products have a set investment term, and are designed to be held for the entire term of the investment, which may be as long as 5 or 6 years. Thus they are not suitable for investors who need ready access to their capital. Whilst there may be a secondary market for some structured products, this market may not be very liquid, and there is no guarantee that a buyer will be found. Therefore, structured products may not be suitable for an investor who may need immediate or short term access to their capital.
Restriction on Upside GainsThe restriction of potential upside gain is a key point which is often overlooked by advisers when explaining the features of a structured product to a client. In order for the structured product to offer the benefit of some form of capital protection (or, in some cases, a 100% capital guarantee), there is often a cap placed on the performance return on the product. For example, if the return of a structured product is referenced by the FTSE 100 index, then there may be a cap of 12% placed on the upside – ie if the FTSE makes a return of 15%, or 20%, the structured product will only return 12%. Thus if there is a significant and prolonged bull run in the equity markets (or whichever market is referenced by the structured product), then the product will return less. However, this should not necessarily be seen as a ‘risk’ or ‘disadvantage’ of a structured product. It is merely a feature of the product – and when used properly as a portfolio management tool, can help in reducing the volatility of a portfolio, which is one of the key advantages of using structured products.
For more information about Structured Products, please contact us.