Imagine the investment world with products which are capital guaranteed and provide you with positive returns. Or better still, products with guaranteed returns much higher than your conventional fixed income products. Well, there are investment options which provide you exactly this!
Structured products are financial innovations that are becoming part of investment portfolios.
Structured products are tailored to facilitate highly customised risk-return objectives. The underlying asset class could be equities, derivatives, debt, real estate and so on. Or a combination of asset classes. Normally, they have an entry-level corpus of Rs 50 lakh. However, of late, there are numerous products with a much lower entry level,a minimum of Rs 5 lakh-15 lakh which could be looked at.
One of the most popular types of structured products are equity-linked debentures (ELDs).It is an instrument that provides investors fixed income-like principal protection, together with an element of equity market upside. These schemes invest in short and medium-term debt instruments. Schemes may also choose to invest in derivative contracts. You profit with index-linked returns (one may get a part/or all of the market return) when markets go up, the returns are capped to a certain percentage. When the markets are stable, you can gain on index-linked returns, with no downside risk. When the markets are down, you do not lose your capital.
These investments are ideal when the markets are on a downtrend and one is unsure if the markets have actually bottomed out. The portfolio will carry a credit risk, linked to the ELD issuers. These schemes normally hold a fixed coupon and then provide index-linked returns, based on the participation rate.
ELDs are non-convertible debentures, with coupons or returns categorically linked to movement of any specific equity index. Fixed income instruments, especially bonds, are used to protect the principal. And, equity index/stock exposure is sought with positions in call options.
Interestingly, ELDs are packaged such that their risk level falls between equity instruments and fixed maturity plans. The charge structure is fairly simple, with an entry load and an exit load applicable on pre-mature exit; these types of products come with a typical lock-in period ranging between one and three years.
DECODING THE JARGON:
- Participation ratio: Ratio at which an ELD participates in appreciation of the underlying equity index.
- Knockout Event/Level: A knockout event occurs if, any time during the duration of scheme, the index level has increased from the starting level by more than the percentage mentioned at the time of issuing of the ELD.
- Knockout Coupon: Is a fixed coupon paid in the event of the underlying index hitting the Knockout Level.
- Closing Value: Index returns calculated based on the average of the last three months
- Barrier Rebate: Is similar to the hurdle rate of any other product; the index-linked returns would kick-in post such rate
Structured products bring many of the benefits of derivatives to investors who otherwise would not have access to these. However there is no free lunch - while structured products do usually protect the downside, returns get capped.
KEY TAKE AWAYS:
- A good means to gain some upside at relatively low levels of risk.
- Portfolio can move across various asset classes.
- Participation in derivatives, otherwise a risky instrument.
- Works very well during bearish trends in the market; tends to underperform in a bull run.
- Ideal way to participate in equities during uncertainty and when one has a conservative outlook. However use it for part of your portfolio, since in some scenarios, it may deliver lower returns.
The writer is CEO, Right Horizons