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Demystifying 7 Myths of Investing in Structure Products

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Myth 1Structured Product is a Black Box

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It may not be simple, but it is not complex either

Let us deconstruct with an example

Protected Call Series VIII - ARG/FY2013/JAN/10 Underlying : Nifty

Tenor : 1237 days

Coupon : 61%

Decay Multiple : 1.75

Payoff : Max(-100%,Min(Coupon, Coupon + DM * NP))

Protected Call Series VIII - ARG/FY2013/JAN/10 Underlying : Nifty

Tenor : 1237 days

Coupon : 61%

Decay Multiple : 1.75

Payoff : Max(-100%,Min(Coupon, Coupon + DM * NP))

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Payoff Chart

-61.00%

-40.67%

-20.33%

0.00%

20.33%

40.67%

61.00%

81.33%

Nifty Returns Product Returns

Payoff Table

Final Nifty Levels Nifty Returns Product Returns

3600 -40.00% -9.00%3800 -36.67% -3.17%4000 -33.33% 2.67%4200 -30.00% 8.50%4400 -26.67% 14.33%4600 -23.33% 20.17%4800 -20.00% 26.00%5000 -16.67% 31.83%5200 -13.33% 37.67%5400 -10.00% 43.50%5600 -6.67% 49.33%5800 -3.33% 55.17%6000 0.00% 61.00%6200 3.33% 61.00%6400 6.67% 61.00%6600 10.00% 61.00%6800 13.33% 61.00%7000 16.67% 61.00%7200 20.00% 61.00%7400 23.33% 61.00%7600 26.67% 61.00%7800 30.00% 61.00%8000 33.33% 61.00%8200 36.67% 61.00%8400 40.00% 61.00%8600 43.33% 61.00%8800 46.67% 61.00%9000 50.00% 61.00%9200 53.33% 61.00%9400 56.67% 61.00%9600 60.00% 61.00%9800 63.33% 61.00%

10000 66.67% 61.00%

*Assuming initial nifty of 6000

Initial investment : Rs. 100Park the initial investment at 11.25% p.a.Returns after 1237 days: Rs. 144

Earn premium by selling 1.75 PUTS at Rs. 11Park the premium amount at 11.25% p.a.Return after 1237 days : Rs. 17

Total Inflow at maturity: Rs. 161

Construction

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Product Strategy & Corresponding Payout

Final Nifty Levels in %

Payout of Step 1

Payout of Step 2

Payout of Step 3

Payout of Step 4 Net Payout

-40% 144 -40 -30.00 17 91.00

-30% 144 -30 -22.50 17 108.50

-25% 144 -25 -18.75 17 117.25

-20% 144 -20 -15.00 17 126.00

-15% 144 -15 -11.25 17 134.75

-10% 144 -10 -7.50 17 143.50

-5% 144 -5 -3.75 17 152.25

0% 144 0 0 17 161.00

5% 144 0 0 17 161.00

10% 144 0 0 17 161.00

15% 144 0 0 17 161.00

20% 144 0 0 17 161.00

25% 144 0 0 17 161.00

Product Strategy

Step 1Invest principle amount Rs.100 with treasury @11.25% for 1237 days which will grow to Rs.144

Step 2Sell Insurance, on Nifty, whichprovides 100% coverage to Mr. X and earn Rs 6.29 premium

Step 3

Sell Insurance, on Nifty, which provides 75% coverage to Mr. Y and earn Rs 4.71 premium i.e. Total premium earned is Rs.11

Step 4Invest total premium of Rs.11 with treasury @11.25% for 1237 days which will grow to Rs.17

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Myth 2 Structured Product is an Alternate Asset Class

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Structured product is not a product, it is a platform or a wrapper like amutual fund

Structured Product can form a part of the core portfolio based on theunderlying features of the product

For example, high participation based products can be part of theequity portfolio where as fixed coupon products can be plugged in thedebt portion of the portfolio

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Myth - 3 Structured Products Never Make Money

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Structure Name Tenure(Months)NIFTY

ReturnsSP

ReturnReturns Alpha Coupon

Product Features

RELIGARE PMS APF (Barclays) 36 61.6% 114% 52% 175% PR product

Milestone NIFTY Linked SPS LVIII (Macquarie INE796L07258) 16 19.31% 46.74% 27%

Coupon 8% plus 200% PR product with contingent & KO

Milestone NIFTY Linked LXV(Macquarie INE796L07274) 16 18.08% 39.61% 22%

Coupon 14% plus 150% PR product with contingent & KO

MILESTONE NIFTY LINKED SPS VII (ECL) 24 -1% 18% 19% 18%

18% Fixed coupon with 40% PR and 100% downside PP

Milestone NIFTY Linked SPS L (INE804I07BN8) 18 4.56% 22.00% 17%

Coupon of 22% with downside contingent of 75%

Religare PMS SPS VI (ECL) 15 3% 21% 17% 16.50% 21% auto call coupon

MILESTONE GOLD LINKED SPS I (Edelweiss) 24

51.46% 90% PR with 100% downside protection

Actual Performance of Some of the Structured Products

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Myth 4Structured Products are Very Risky

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The approximate size of Structured Products market in India today isUS$ 4 Billion*

Not a single default or delay by any issuer till date, since the inceptionof structured products in India

*Source - http://www.risk.net/structured-products/news/2135331/-net-worth-investors-india-alternative-assets-report

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Myth - 5 Rating is the only criteria

.

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Perceived Risk Actual Risk

Rating generally reflects the perceived

risk of the issuer.

Rating agencies have set parameters for

rating an issuer. While it is an important

criteria, it cannot be the only criteria for

evaluating the risk.

Actual risk of the issuer can be assessed

by considering various aspects:

Due diligence on balance sheet

Line of business activity

Parentage

Understand the risk mitigating

measures of the options desk

(% of OTC contracts..etc).

Issuer Risk Assessment

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Myth 6Principal Protection is a must

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100% Principal Protection may not be necessary on all Structure Products

Non Principal Protected or Partial Principal protected products can havebetter Risk Reward payoff

3 Years Rolling Returns of nifty from 2003 to 2013 suggest that, Nifty has never dropped below 20% in any of the 3631 observations.

-50.00%

0.00%

50.00%

100.00%

150.00%

200.00%

250.00%

300.00%

350.00% 3 Years Nifty Rolling Returns for the past 10 Years

Redemption dates

Ret

urns

(%)

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Myth 7Costly Affair & No Exit Mechanism

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Cheaper Investment Option One time 0.5% to 3% fees against 2% management fees annually

charged by Mutual Funds.

Easy Exit Mechanism Unwind quotes are available almost on daily basis

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Thank You

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