According to the Structured Products Association (SPA), in 2006 the industry issued $63.7 billion in notional products, up 33% from the $48 million a year ago. More than 2,300 new structured products were introduced to the U.S. market last year. Nearly half of 2006 sales were from retail-targeted structured products.
The U.S. has lagged Europe in mass distribution of structured products. In Europe, consumers can access these vehicles through their national post offices and even supermarkets. There and in Asia, it is not uncommon for investors to hold up to 30% of their portfolios in structured investments.
Recently, an advisor shared with me how many new referrals he has been getting from his existing top clients, based on his discussions about structured products and how they play a part in overall asset allocation.
One of the challenges of structured products is that they have become an "it" product, yet many investors don't really know what "it" is. According to a recent report by Spectrem Group, they are understood by only 15% of affluent investors.
So, while there is increased chatter about the topic, there is an even greater need for education, creating an excellent opportunity for you to add value to your existing client relationships. Not only will you be presenting a possible innovative solution, but the conversation about suitability and fit gives you the opportunity to learn even more about your clients' risk and return objectives. As with most investment offerings–education is key. Sales traditionally follow if people understand the products.
Why structured investments?
Structured investments are used most often to protect principal, enhance returns and more closely align the investment with the investor's market and economic views. The ultimate goal is to develop an investment with a better risk/return outcome than its original underlying market exposure.
To help you and your clients assess whether these products may be a good fit, consider these three market conditions:
1. Increased desire for alternative methods of portfolio diversification–Clients who are looking for diversification in their portfolios need to look beyond the usual stocks-and-bonds approach.
2. Baby boomers are living longer–If boomers expect their savings to last through retirement, they should have greater equity exposure than retirees of the past and, most likely, greater downside protection.
3. Market volatility is on the rise–In these times of heightened volatility, clients may feel the need for downside protection, to help safeguard them from themselves and their irrational behaviors. This could be a way to provide clients with options that may buffer their portfolios when markets are volatile and their fears are heightened.
Another opportunity for discussion is with clients who have specific investment periods and want to guarantee their principal for a specific use in the future. By matching the investment period with the product maturity, you may be able to provide these clients with more enhanced opportunities than traditional shorter-term investment vehicles.
Most structured investments fall into one of three categories, each with its own risk/return profile. At JPMorgan, we refer to these investments as: principal-protected, buffer-zone and return-enhanced.
Principal-protected investments offer the full downside protection of a bond while having the upside potential of a typical equity investment. Investors typically give up a portion of the equity appreciation in exchange for principal protection.
These are often of interest to clients wishing to participate in some of the more volatile asset classes or emerging markets, but are unwilling to risk their principal or may have long-term financial obligations.
Generally, investors will receive 100% of the principal amount of their notes if they are held to maturity, regardless of the performance of the underlying investment. Maturities often range from five to seven years, and clients should intend to hold the investments to maturity.
Be aware though, that a principal-protected note is backed by the firm that issued the note. In case of bankruptcy of the issuer, the note holder would be repaid at a rate equivalent to other senior unsecured debt holders of the firm. Principal-protected notes are not FDIC insured.
Buffer-zone investments, in exchange for risking principal, offer investors greater upside potential with these investments relative to a fully principal-protected investment. In general, buffer-zone investments can be structured to have a shorter maturity than principal-protected investments, often in a two- to four-year span.
