Investing surplus cash in structured products

This page was last modified on 30-01-2013

Structured products offer a means of diversification that can increase the return on assets while limiting risks. They involve a contract between two parties traded over the counter (directly between the parties) or on a stock market. Structured products generally comprise 2 or more financial instruments:

  • a traditional instrument (e.g. a bond);
  • a derivative instrument (linked to an underlying asset).

The purpose of structured products is to offer businesses an investment that combines the advantages of a traditional low-risk instrument (high level of capital protection) with the advantages of a high-risk derivative instrument (high yet unpredictable return) while retaining the liquidity and availability of the capital.

Structured products can be tailored to meet the requirements and expectations of the investor in terms of the risk/return ratio and market trends.

Objective: structured products are used to invest and manage a business' cash.

Who is concerned

Available to financial institutions, institutional investors, large businesses, government entities and, more rarely, small and medium-sized businesses, structured products are used:

  • as a hedging instrument:
    • against adverse price fluctuations (raw materials, currencies, etc.);
    • against adverse changes in interest rates;
  • as investment instruments:
    • surplus cash not needed in the short term;
    • a more attractive investment than a term deposit.

Prerequisites

The prerequisites to accessing structured products are:

  • the existence of a current account (or securities account) to be used to subscribe structured products;
  • knowledge of the basic concepts regarding the financial markets, allowing an understanding of how the different structured products work and the risks involved;
  • signature of an agreement in which the investor acknowledges having been adequately informed and advised by the bank.

How to proceed

Description of structured products

Application terms and conditions

Amount
  • standard structured products:
    • generally no minimum amount;
  • specific structured products:
    • minimum amount required by the banks or counterparties.
Duration
  • short to medium-term;
  • duration may vary from a few days to several years.
Return

The return on structured products varies depending on the performance of the underlying asset and the type of structured product.

Underlying asset

The large variety of structured products is due to the many types of underlying assets that can be used for derivatives. The following categories of derivatives are traded on the markets:

  • index derivatives;
  • derivatives based on equities or baskets of equities;
  • interest rate derivatives;
  • foreign exchange derivatives;
  • credit derivatives;
  • commodity derivatives;
  • inflation-linked derivatives, etc.

It is advisable to invest in structured products that are in some way related to the activity of the business in order to improve its risk profile. Where this is not the case, the risk increases significantly and purchasing this kind of product quickly becomes speculation.

Types of structured products

Considering the number of underlying assets, the range of structured products is almost unlimited. However, the most commonly used products are:

  • guaranteed capital products: guaranteed capital products are defensive products that ensure that the invested capital is recovered at maturity and that offer either a limited return or a lower return than that of the underlying asset;
  • performance optimisation products: performance optimisation products are products where the capital is partially or fully exposed and, in exchange, offer the possibility of a higher return (limited or unlimited), but generally lower than that of the underlying asset;
  • participation products: participation products are used to participate fully in the performance of the underlying asset, without capital protection;
  • leveraged products: leveraged products are products with unlimited risk that offer the possibility of a higher yield than that of the underlying asset.
Set-up times

Subscription times for structured products depend on supply and demand on the market at a given time:

  • different standard structured products are always available on the market and can therefore be subscribed on the day of the request;
  • if the business is looking for specific structured products linked to its activity or risk profile, it must ask its bank to propose a suitable solution.

Advantages, disadvantages and risks

Advantages

  • possibility of high returns;
  • optimisation of investment of surplus cash through greater diversification;
  • access to non-traditional asset classes;
  • possibility of participating in the global risk management of the business;
  • products tailored to the requirements and expectations of the business.

Disadvantages

  • subscription costs are sometimes high;
  • lack of flexibility as they require good cash management;
  • lack of liquidity where it is not a standard structured product.

Risks

  • risk of unforeseen events requiring the release of the money invested and forcing the investor to sell the structured products on the market before maturity, which may result in a loss or cause the business to miss out on gains;
  • risk of a negative change in the underlying asset resulting in no return;
  • it is a complex product that sometimes involves high risks and is only suitable for well-informed investors.