Structured Investment
The word “structure” defines by Free Dictionary as “something made up of a number of parts that are held or put together in a particular way” or “the way in which parts are arranged or put together to form a whole”.
In relate the word “structure” to investment term then it simply means as an investment product that is a pre-packaged investment strategy based on derivatives. Derivatives is defines as a contract that derives its value from the performance of an underlying entity or combination of few entities.
The underlying entity can be an asset like gold, silver, commodities or index of share market, gold future, option, or interest rate futures and options, a single security or a basket of securities, debt issuance and/or forex in single currency or multi-currencies. Hence, the structure product is also known as a market-linked investment based on these entities.
A typical feature of some investment structured products is a "capital guarantee" function, which offers protection of principal if held to maturity. For example, an investor invests $1,000 in a 5-year capital-guarantee product and the issuer may just simply invests in a risk-free bond that has sufficient interest to grow to $1,000 after the five-year period. This bond might cost $800 today and after five years it will grow to $1,000. This would give a protection of capital for the 5-year investment plan. With the leftover funds of $200 the issuer purchases the options and futures needed to perform whatever the investment strategy.
As such, structured investments were designed to meet specific needs that cannot be met from the standardized financial instruments available in the markets. Structured investment can be used as an alternative to a direct investment, as part of the asset allocation process to reduce risk exposure of a portfolio, or to utilize and capitalize the current market trend.
How structured investments work?When you buy a structured investment, you also agree to tie up your money for a pre-determined period. Some of these products offer you a lump sum at maturity depending on the performance of the underlying entities.
Examples of structured investments:
If the Bursa Malaysia is at the same level or lower than it was at the beginning, but is less than 50% lower, you get your original investment of $1,000 back but nothing extra.
If the Bursa Malaysia has fallen by 50% or more, the amount of your original investment you get back is cut by the same percentage – so if the Bursa Malaysia has fallen by 60%, you’d only get 40% of your money back, a total of $400.
Other structured investments let you take a regular income and whether or not you get back your original investment in full depends on how the stock market index or other measure has performed. If the stock market falls, you can lose a very large chunk of your original investment.
Risk of structured investments
Structured investments are commonly offered by insurance companies, banks and private fund managers. Your money typically buys two underlying investments, one to protect your capital and another to provide the bonus. The return you get depends on how the stock market index or other measure performs. In addition, if it performs badly or the firms providing the underlying investments fail, you may lose some or all of your original investment.
The risks associated with many structured products, especially those that present risks of loss of principal due to market movements, are similar to risks involved with options. The serious risks in options trading are well-established and customers must be explicitly approved for options trading. The Securities Commission Malaysia (SC) suggests that firms "consider" whether purchasers of some or all structured products should be required to go through a similar approval process, so that only accounts approved for options trading would also be approved for some or all structured products.
"Principal-protected" products are not always insured by the Perbadanan Insurans Deposit Malaysia (PIDM) in Malaysia and thus could potentially lose the principal if there is a liquidity crisis or bankruptcy. Some firms attempted to create a new market for structured products that are no longer trading; some have traded in secondary markets for as low as pennies on the dollar.
If you take out a structured investment with, say, a bank or insurance company it’s not usually that firm which promises to return your original investment or to pay a given return on your money.
Instead the bank or insurance company will buy some complex underlying investments from one or more other companies, often referred to as ‘counterparties’.
Because you don’t have any agreement yourself with the counterparties, if any of them fails – so that your structured investment fails to give you your money back or provide the promised return – you don’t have any direct claim on the counterparty and no compensation scheme would apply.
Instead, you would have to try to seek redress from the bank or insurance company that sold you the product or any adviser who advised you to take it out. You would have to show that the bank, insurance company or adviser had not made the risk of the counterparty failing clear to you.
In addition, banks selling structured products often talk about ‘capital protection’ – but this doesn’t necessarily mean that your money’s completely safe. There are two common types of protection:
Full protection – also described as ‘100% capital protection’, ‘capital security’ or a ‘capital guarantee’, this means that the minimum that you receive on maturity should be at least equal to the amount originally invested.
Partial protection – how much of your original money you get back depends on the performance of the index your product is based on and only a proportion – say 90% - is protected by the capital ‘guarantee’.
In either case, there is still potential for capital loss as described above, if the company providing the guarantee runs into trouble.
Information you should be given for structured products
Structured investment product providers must provide you with ‘key facts’ information that you can understand, covering:
1. What the investment is and how it works
2. The key risks including the risk of capital loss and counterparty risks
3. Charges (the fees that will be deducted from your returns or capital)
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