Business Today
Loading...

Fitted to your choice

Tailor-made structured products provide capital protection and add the kicker of equity-like returns to your portfolio. Their design might look complicated, but they are not.

Clifford Alvares | Print Edition: September 7, 2008

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.

Puneet Matta, Head India, Wealth Management, Credit Suisse Securities
Puneet Matta, Head India, Wealth Management, Credit Suisse Securities
They are essentially debentures, similar to the ones in the fixed-income market. But they also invest in the options market and that’s what gives them a distinct flavour. They are called structured products.

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.

  • An investor invests Rs 10 lakh in a capital protection plan

  • The issuer invests Rs 7.51 lakh in a bond yielding 10% per annum. The interest plus the principal, thus, add up to Rs 10 lakh in three years

  • With the remaining Rs 2.49 lakh, the issuer participates in call options of the underlying index or basket of securities

  • At maturity, after three years, the investor gets his capital back, and a part of the stock market's gains (depending on the product), if the market performance is positive
But over time, the level of sophistication will only increase. Says Puneet Matta, Head India, Wealth Management, Credit Suisse Securities: “In India, they are relatively new and form still a small part of the market. The type and levels of sophistication have a long way to go.”

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
Maturity: 39 months
Underlying: S&P CNX Nifty
Principal protection: 100%
Coupon: 85-95% (depends on launch date)
Payout: Principal+coupon
Note: An investor will receive 100 per cent of invested principal, and 85-95 per cent of the positive performance of the underlying index. The investor’s principal will be protected at the end of 3 years, if the underlying index ends lower than the initial level.

Capped Nifty participation
Maturity: 39 months
Underlying: S&P CNX Nifty
Principal protection: 100%
Coupon: 95-100% (depends on launch date)
Payout: Principal+coupon
Note: An investor will receive 100 per cent of invested principal, and 95-100 per cent of the positive performance of the underlying index up to a capped level of 100 per cent. The investor’s principal is protected at the end of three years, if the underlying index ends lower than the initial level.

Nifty knockout
Maturity: 39 months
Underlying: S&P CNX Nifty
Principal protection: 100%
Coupon: At knock-out, 57-65 per cent is paid at maturity (depends on launch date) or else 135-140 per cent of the index performance
Payout: Principal coupon
Knock-out level: 190% of the initial level of underlying
Note: An investor will receive 100 per cent of invested principal, and 135-140 per cent of the positive performance of the underlying index provided the index does not cross the knock-out level of 190 per cent. If it does, the investor gets paid only a flat payout of 57-65 per cent at maturity. The principal is protected if at the end of 3 years, the underlying index ends lower than the initial level

Fixed & Capped Nifty
Maturity: 39 months
Underlying: S&P CNX Nifty
Principal protection: 100%
Coupon: Fixed: Flat 24-25% payable at maturity Index-linked: 40-50 per cent of underlying index up to a cap of 100 per cent
Payout: 100% Principal + coupon
Note: An investor will receive 100 per cent of invested principal, and a coupon of 24-25 per cent paid at maturity. In addition, the investor receives a 40-50 per cent of positive performance of underlying index, up to a cap level of 100 per cent. The principal is protected if at the end of 3 years, the underlying ends lower than the initial level.


A slice of the market

While capital-protected structured plans offer you a toehold in the equity market, your returns depend entirely on how the stock markets perform. And for them to deliver the promised capital appreciation, investors have to hold them for their full term, which can range from 18 to 36 months. Says Suresh Soni, CEO, Deutsche Asset Management: “The popular plans range from 18 to 36 months with capital protection. The ‘market participation’ depends on the structure of the product.”

 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.

In structured product parlance, market participation is the amount of upside you will get against the upside of the underlying index or the underlying security. In a 100 per cent market participation product, if the underlying index or the stock were to move up 50 per cent, investors will get their capital back and 50 per cent of the underlying index’s movements.

Suresh Soni, Chief Executive Officer, Deutsche Asset Management
Suresh Soni, Chief Executive Officer, Deutsche Asset Management
Among the other types of products for investors are capped participation plans with capital protection, which essentially give a return up to a certain point in the market. For instance, a product can fix a cap of 100 per cent of the market’s rise. If the underlying index goes beyond 100 per cent, an investor’s gains are restricted to 100 per cent only. The investor does not get to participate beyond a gain of 100 per cent in the market.

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

Investors, particularly high net worth individuals, can go beyond the off-the-shelf products and even have these products customised to their liking at a higher capital outlay. For instance, if you are bullish on, say, technology stocks, you can structure a product taking a call on a select IT stocks. If your call goes right, you rake in the profits. Given the different types of combinations and choices, there are many ways in which these equity-linked notes can be customised.

Youtube
  • Print

  • COMMENT
Page 1 of 2 Next >  >>
BT-Story-Page-B.gif
A    A   A
close