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Last Updated : Aug 17, 2019 07:56 AM IST | Source: Moneycontrol.com

How structured products may enhance returns significantly

A structured product is an instrument that can be tailored in multiple ways

Moneycontrol Contributor @moneycontrolcom

Jay Shah

When you are looking for a portfolio to construct, make sure you know what a structured product is.

A structured product is an instrument that can be tailored in multiple ways. These are manufactured by few entities to provide a risk-to-return that is not available in a conventional way.

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These can be a combination of listed or unlisted and market-linked or plain vanilla debt that could be secured or fall in the unsecured category. Various issuers that have varying credit have issued almost USD 1.7 billion of these products in FY19.

Some of the well-known issuers to have hit the market with structured products recently are names like Edelweiss, CitiBank, ABFL, MMFSL, etc.

In the current NBFC crisis, this has given a steady flow of liquidity to manage the ALM on the balance sheet of the companies which issued these products.

The taxation arbitrage that currently exists for listed, market-linked structures products provide an edge over the vanilla bond that pays out interest.

In fact, if the structured product is sold in the open market (post one year), it translates to a taxation of as low as 10 percent.

For this favourable taxation, this has recently been a must-have product with HNI’s who are happy to look at equity returns with a debt product risk. The minimum investments on these products start at Rs 25 lakh.

While the above is a simple example, various structures include:

1. Flat debt structure with Yield (Debt Alternative)

2. Higher of the Debt structure or market movement (Twin Win)

3. Upside and downside participation linked to markets (Either way you win!)

4. Capital Guarantee with a multiplier on the upside of market movement (Equity Alternative with debt risk!)

5. Complete customization for a payoff – Mainly provided when amounts are huge and investors cannot directly participate in the markets.

Let's take an example:

The payoff is as follows: 1.25 times Nifty return on the positive side and capital guarantee on the negative side (three-year product).

Let’s say the amount of investment is Rs 1 crore. Now, out of this, Rs 75 lakh is deployed in a 10 percent coupon-bearing bond to mature at Rs 1 crore in the next three years.

This takes care of the capital guarantee (debt risk). Further, let's say, we have a three-year ATM Call options trading at Rs 2,000 (Assume Nifty = 10,000).Hence, I can get 1,000 shares, which will give me a notional value of Rs 1 crore with another five lakh remaining. I can now purchase an additional 250 shares of the same ATM Call option.

Magically, now, even if the Nifty detracts, my bond exposure protects my downside, and my call options will give me 1.25 times of any positive Nifty return.

While all of the above looks risk-free, the risk lies with the issuer. Think of when we make an FD. It is with the assumption that the bank will be solvent when the FD matures.

If the issuer defaults, your principal could also be in jeopardy.

While fees are almost always built in to the structure, it is important to always evaluate the issuer of these products, how wide and deep is the balance sheet? How long have they been doing this for?

Are they off the shelf or available one time? Why are they raising the money? What is the liquidity on them? Most of these issuances while listed, have poor liquidity. They are almost always held to maturity product.

Mutual Funds toh sahi hai lekin structured products ko dekha hai?

This is a three-part series on Alternative Investments Funds. The author is Founder at One Tree Hill Wealth Partners.

Part 1: 'Mutual funds toh sahi hai but alternatives may deliver better returns'

Part 2: Stuck with losses? Here are 7 ways to pick a PMS for your portfolio

Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.




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First Published on Aug 17, 2019 07:56 am
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