Fitted to your choice
It’s the new buzz in the financial world and a rage with thousands of investors. They are notes tailored for you in a way that allows you to make the best of both worlds: participate in the upside of the equity market, and, yet, have the safety of the fixed-income market. Their design might make them look complicated at first glance, but they are not.
Introduced in India in the latter half of 2007, structured products have already caught the fancy of high net worth individual and thousands of mutual fund investors. Their market size has zoomed from zero to an estimated Rs 1,500 crore in less than a year. And this segment is growing fast. Says Pradeep Dokania, Head of Global Private Clients, DSP Merrill Lynch India: “These products are very popular overseas where their market is huge. In India, we have just entered its earliest phase.”
These products can be designed in many ways and can combine the best of the commodities and the currency markets. As of now, structured products are usually a blend of both the equity and the debt market, and issuers have kept their structure relatively simple.
Inside the structure A look at how a capital-protection plan is structured.
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Designed for protection
Banks are the main issuers of structured products in India. At the core of the product lies a simple strategy of investing a part of the corpus in debt, and the remaining in the options of an underlying security or an index or a basket of securities.
In this volatile market, the most popular product is the one that keeps an investor’s capital safe—the capital protected structured product. This note allows you to enjoy the upside of the market. They are benchmarked to an underlying index, which, in India, is usually the S&P CNX Nifty, in an equity-linked debenture. If the index dips lower, your initial investment is safe.Equity-linked debentures are growing popular by the day. With the equity market in a state of flux, many investors are wondering whether to invest in the stock market. If one stays out of the market, investors can lose the opportunity if the market goes up. On the other hand, an existing investor loses when the market falls. A capital-protection plan provides the leeway for the investor to keep his capital intact and also participate in the market. Says Matta: “Given market volatility, structured products with capital protection are most popular. They are efficient alternatives to equity and fixed income investments.”
In a capital-protected plan, the issuer invests a bulk of the corpus in debentures that accumulate to your entire invested capital. The remaining is invested in the options market of the underlying security or a basket of securities.
While capital protection plans are growing in stature, products without capital protection have also made a beginning in the Indian market. As of now, they form a minuscule portion of the equitylinked debentures market. And due to their structure, these notes participate more aggressively in the stock market. But these products are fraught with risk. If the underlying index or basket of stocks does not perform well, investors can lose their capital.Just the right structure There are many structures that can be customised for investors. Here are some popular illustrations of the plans. Nifty participation Nifty knockout Fixed & Capped Nifty |
A slice of the market
What’s the alternative? Small investors can participate in equity-linked debentures through the mutual fund route. Small investors can also have a slice of unique structured products that allow you to participate in the stock market’s performance. Mutual funds, too, have launched their own versions of these equitylinked fixed maturity plans for small investors. Among the first mutual funds to launch an equity-linked capital protection was Deutsche Asset Management with the launch of DWS Fixed Term Fund-Series 43, which closed on February 27, 2008. Prudential ICICI Mutual Fund and Birla Sun Life AMC are among the others that have launched capital protection plans with an equity-linked option. |
Other products include knockout products, where the investor gets only a basic return if the index goes beyond a certain level.
The custom-made debenture
When should you invest? Capital protection plans are not foolproof; you must do your homework.
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While investors can make the product complex, you must look at the cost as well. A complicated structure has a higher in-built cost and this reduces its gains. Besides, resellers and distributors may also charge a fee of 2-4 per cent.
The spook in the note
Another problem these structures could face is that of a credit default or an issuer risk if the issuer goes bust. Credit rating agencies issue a different kind of rating for these products, but they usually take a call on the principal-protected portion of these notes. Says D. R. Dogra, Deputy Managing Dvirector, Care Ratings: “Our capital protection-oriented scheme ratings are opinions on the degree of certainty with which the portfolio structure ensures timely payment of at least the face value of the units to unitholders on maturity. We assess the investment strategy of the issuer, the track record and the prevailing market conditions.”
But when should you invest?
One way investors can profit from these notes is when the stock markets, or the underlying index, are not performing as per expectations. At such times, the capital-protected plan can, at the very least, offer your principal back. Also, with equities, investors often can’t tell with certainty the direction of the market, particularly in volatile times. It’s during these times that this product offers a good cushion.
You may also want to calculate your pay-offs on a yearly basis. Banks and issuers note the pay-off on an absolute return basis, which is higher when calculated on an annual compounded basis. For instance, an absolute 100 per cent return on a three-year basis is equal to 25.99 per cent on a yearly compounded basis.What’s the breakeven? A look at your pay-off scenario in an equity-linked debenture with 100 per cent participation.
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By comparison, an investment in debt can yield you about 10 per cent return through fixed maturity plans. If your equity-linked debenture has to match that return, the underlying index (usually the Nifty) has to rise by around 40 per cent in a standard 100 per cent participation product. In short, the stock market has to do well for your investment in equity-linked debentures to deliver exceptional returns.
While these products do have a place in your portfolio basket, experts say that your investment should factor in your broad asset allocation. Says Krishnan: “A structured product is a phenomenal tool. It is important to understand the payoff. For bullish investors, who want a downside protection, capitalprotected structured notes are just what the doctor ordered.
