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Don't get lured by exotic structures

Invest in such products only if a mutual fund or direct equity investment can't do the job

Ashley Coutinho 

With the equity market's revival in the past 18 months, structured products - popular among wealthy individuals before the global financial crisis hit in 2008 - are regaining traction.

"These have seen a resurgence in the past year," says Sunil Mishra, former chief executive of Adds A V Srikanth, chief executive at Citadelle Asset Advisors: "We have a lot of capital protection-oriented products and auto-call products being sold. Some are around interest rates or behaviour of debt funds around them."

Structured products are typically based on or derive their value from an index, commodity, debt issuance or a foreign currency. They have a fixed maturity date and are designed to facilitate customised risk-return objectives. Capital protected or principal-protected structures are so designed that the client's initial capital is protected even if the market falls. Currently, most structures have the Nifty, the benchmark index of the National Stock Exchange, as their underlying product.

Pre-2008 and now

"Despite some traction in recent months, the structured product market is down 60-70 per cent from peak levels. About 60-70 per cent of the structured market in 2007-08 was non-principal protected products; their number is almost zero now," says Umang Papneja, chief investment officer at

Experts say the market before 2008 was dominated by three or four big multinationals players - Citi, Merrill Lynch, Barclays and Deutsche. Only Citi is active now and caters largely to its own captive wealth management client base. Pre-2008, each issuance was in excess of Rs 30 crore; now, it's Rs 5-10 crore.

The other notable change is in the decline in participation and non-principal protected structures. Participation structures offer returns pegged to the achieving a target. For example, there could be a structure offering 1.5x for every x movement in the market. Let's say if the market moved up 30 per cent, you get a 45 per cent return (30*1.5). "There was a lot of disappointment from these structures post 2008, as the market didn't hit the desired levels. But investors forget there was nothing wrong with the product per se; it's the investors' views that went wrong," says Feroze Azeez, executive director and head of investment products, Anand Rathi Private Wealth Management.

Now
Flat market and auto-call structures have gained popularity in recent times. In a flat market product, the investor gets a flat absolute coupon of 50-55 per cent in three years if the market is up by only five per cent from the initial level in that period. "Structures which are more oriented towards fixed income/coupons have become more popular," says Papneja.

In an auto-call, the money is returned to the client if a certain target is hit. For example, there could be an auto-call 8,000 product, which gets activated on a 10 per cent upside or on reaching 8,800 levels. There will observations every quarter or every month to see whether 8,800 (10 per cent up from the initial level of 8,000) has been reached. The moment the target is hit, you get a coupon of 13-14 per cent. If the market reaches the target in, say, 12 months you get 14 per cent; if in 18 months, you get 21 per cent (14+7 per cent).

Advice
According to Srikanth, 80 per cent of the structured products have not delivered the promised return experience. "The timing of each structured product in the context of the market is important. Most of these products seem to be structured in a way that the probability of getting the issuer's call right is much higher," he says.

"Don't buy structures if a simple or direct can do the job. Avoid binary outcome and path-dependent structures where a few variables can negatively impact returns," says Azeez.

Srikanth says before investing, the investors should insist that advisors share the back-tested statistical analysis of the probability of making money through the structures. "Don't simply look at the features and benefits. Calculate the probability of the underlying (product) making money and assess the opportunity cost in case the structure does not meet its objective," he says.

Keep the tax angle in mind. For instance, gains from unlisted auto-call structures redeemed before three years are taxed at 33 per cent before three years and at 20 per cent after three years. Listed auto-calls are taxed at 10 per cent after one year and at 33 per cent before one year. "If your auto-call is activated before your target period, there could be tax implications," says Azeez. Also, note that the indexation benefit is not available on debentures.

THEN AND NOW
  • Flat market and auto-call structures have gained popularity in recent times
  • Non-principal protected products dominated the scene in 2007
  • The number of these products is now virtually zero
  • About 80 per cent of structured products have not delivered the promised returns
  • Capital protected structures protect the initial capital even if the market falls
  • Pre-2008, each issuance was in excess of Rs 30 crore; now, it's Rs 5-10 crore

First Published: Sun, May 31 2015. 22:18 IST
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