Structured products: an introduction
Want to protect your invested capital while retaining the prospect of a potential return? Investing in structured products makes it possible.
What are structured products?
Structured products are a type of investment in which the return depends on the underlying instrument. The return may depend on how the index or basket of shares performs, or it could similarly depend on the performance of an investment fund, or how a currency rate or an interest rate evolves.
Amongst private investors, the most popular and well-known type of structured product is the structured bond - also known as a structured note (this is the kind of investment that we will discuss below).
How do structured products work?
- You lend an amount to the issuer of the product (usually a bank). This is done by subscribing to or applying for tranches. For example, in one or more tranches of 500 or 1000 euros. Subscription can only take place during a predetermined period of time.
- In exchange for the money that you loan during the lifetime of the product, you become eligible for a fixed or variable dividend payment, depending on the type of product. A coupon can be fixed, or linked to the evolution of an interest rate, underlying index, investment funds, currency rate or another type of underlying instrument.
- If the underlying index does well, then you get a dividend payment. The dividend can be paid to you during the investment term or when it ends. The potential amount of the dividend may be determined in advance (but this is not always the case). If the underlying index does poorly, you get either no dividend, or a smaller payment. Would you prefer a structured product without capital protection, or with partial capital protection (see point 4)? Then the final amount could turn out to be lower than the amount you originally invested.
- Most structured products oblige the issuer to pay back the loaned money on the maturity date, less costs. These are known as structured products with capital protection*. There are also structured products without capital protection or with partial capital protection (for example, 90% of the loaned amount).
Why and when to invest in structured products?
Structured products are mainly popular with investors who want to build a certain level of protection into their portfolio, and at the same time want to take advantage of a potential return or income.
- Protection: most structured products oblige the issuer to repay the borrowed money, or an agreed percentage of it, on the maturity date, regardless of the performance of the underlying index. This is the principle of capital protection. The capital protection does not apply if the issuer goes bankrupt.
- Potential growth. On the (term’s) maturity date the investor gets the potential return which is dependent on the performance of the underlying value.
- Generating potential income. Some structured products issue a coupon periodically (interim interest payment), which again depends on the performance of the underlying value.
Certain market conditions may also play a role in your decision to invest in structured products. Have you had, for example, several successful years in the market behind you, and would you now like to reduce your risk exposure somewhat? A structured product could prove to be the solution, if your investor profile allows it.
An alternative is to invest directly in the underlying share index or the underlying investment fund. The big advantage of doing this is that you are focussing on a higher potential return. The main disadvantage is that you won't have any (partial) capital protection. With a structured product you're trying to bring together the best of both worlds: building in a certain amount of protection while also aiming for a potential return.
How long is my money ‘tied up’?
Most structured products have a fixed term. Terms can run from a few months up to decades. In practice, terms are usually set between 3 and 10 years. If you want to sell this product before its maturity date, the price of the product will depend on market conditions and may involve costs.
Some types of structured products (autocallables) also pay out the invested amount and the coupon before the maturity date.
Are structured products safe?
A structured product is usually constructed from different components: one that offers a certain amount of protection (such as a bond) and an option which is geared to achieving potential return.
ING does not offer its retail customers any structured products that are very complex or not transparent. In this way, the bank is adhering to guidelines set out by the FSMA, the Belgian regulator for financial services and markets (‘the market watchdog’). ING offers retail customers only structured products with full or partial capital protection. Customers under contractual management (Private Banking) do have the option of investing in complex products that do not have (full) capital protection, but only under certain conditions. In contrast to savings or current accounts, structured products do not fall under the deposit guarantee scheme which covers up to 100,000 euros per customer and per bank.
What about return?
In general, a potential return from a structured product is lower than if you were to directly invest in the underlying instrument. This is because with the structured product (that includes capital protection) you are exposed to less risk. The lower the risk, the lower the potential return. Do you want to take more risk (and therefore potentially achieve higher return)? You can do that by, for example, opting for a structured product with 95% capital protection instead of 100%, if your investor profile allows it. The final return on top of your invested amount will, depending on the type of structured product, to a large extent depend on the performance of the underlying index or the underlying fund.
An indication of the potential return can be found in the ‘essential information document’ (also known as KID, or Key Information Document), which you can review for every product. That document also contains various scenarios, from a stress scenario to a favourable scenario. All the costs are shown for these scenarios. It is purely about giving an indication of the potential return: the ‘essential information document’ takes scenarios and market information into account to produce a projected return. It does not represent the actual return. As an investor, you should inform yourself about what the product consists of, as well as what will happen to the potential return if a certain development in the underlying value occurs.
How does it work with taxes?
With structured bonds you pay 30% withholding tax on the added value at the maturity date, or on the interim interest payments (coupons).
Want to invest in structured products?
Investing in structured products is not suitable for every investor. At ING, you can only invest in these solutions if your investor profile allows it.