Module 2: Income Seeking Structured Products
Ben Streater on 24 Feb 2020
In Module 1, we introduced the main types of Structured Products. The next few modules will dig deeper into the mechanics of structured products and explore how investors utilise structured products in different market conditions.
In this module we will focus on structured products where the primary objective is to enhance income. We will also explore popular themes, strategies and define relevant terminology.
With interest rates at historical lows and increasing market volatility, many investors are actively seeking ways to enhance income from their portfolios. At the same time, they are also seeking to reduce their market risk and preserve their capital.
The “Income Seeking” category of Structured Products is by far the most popular structured product type globally, accounting for approximately 60% market share in 2019 (SRP).
How might an investor utilise an income strategy?
Consider an investor who likes a particular basket of shares. Perhaps the investor is of the view that the basket of shares will track sideways with minor fluctuations over the next few years. Rather than owning the shares directly and being exposed to downside price movements, the investor can opt for a buffer to reduce downside risk.
As an example, the investor might be comfortable with the following US shares; Microsoft, Apple, Facebook and Alphabet Inc. Rather than holding the shares directly and being fully exposed to daily price movements, the product can be designed with a 35% downside buffer and generate an income return of 7.0% p.a. The frequency of the income can be structured to be paid quarterly, so the distributions are regular. Along with the regular income that is guaranteed by the Issuer, the Investor receives all of their capital back at maturity as long as none of the stocks fall through the 35% downside buffer.
Consider the below illustration with two market scenarios. In Scenario 1, the prices at maturity have fallen -10% from their initial level. In this case the investor will receive 100% of their capital back, plus the quarterly coupon of 7.0% p.a. This strategy has outperformed an investor who has a direct investment in the underlying.
In Scenario 2, the investor is exposed to capital loss as the prices fell through the downside buffer. Keep in mind that any capital loss from market movements would be partially offset by the 7.0% p.a. income paid to the investor over the term of investment.
In both scenarios the Structured Product would likely outperform a direct investment in the underlying due to the income paid out to the investor.
Key features of income structured products & terminology
Issuer: This is the manufacturer of the structured product. Typically this would be a reputable global investment bank.
Coupon Rate: This is the fixed rate of return paid to investors. Usually this is designed to be a quarterly payment but it can vary depending on the investor’s preferences.
Knock in Level: This is the buffer feature as described above. The investor’s capital may be at risk if the underlying assets fall through the knock-in level. Usually, the knock-in level is set to be observed at maturity, but can be customised based on investor preferences.
Underlying Assets: This refers to what the structured product is exposed to. For example, it may be tracking a basket of shares, an index, managed fund, ETF, commodity or currencies.
Callable / call dates: Often these products may include a ‘callable’ feature, which is when the product may finish prior to the maturity date based on set criteria.
Term/Tenor/Maturity: This refers to the time frame of the investment. Most products are typically 1-3 years and differ based on the investors preference.
How can I find out more?
Should you have any questions or to speak to us about how we can help please contact us at firstname.lastname@example.org
1. Subject to current market pricing, a similar investment was launched in Nov 2019.
2. Subject to Issuer risk