High-net worth individuals, guinea-pigs of structured products
Moneylife Digital team 05 April 2011

Wealth managers continue to pitch high-risk structured products to HNIs. Each time a new set of investors get fooled

Amidst the stock market volatility, and market calls of so-called experts turning out to be frequently wrong, it is not surprising to find investors turning away from equities. Considering the losses they have incurred, market intermediaries don't want to pitch simple equities to investors, especially high-net worth investors (HNIs). One of the products that wealth managers keep coming out for HNIs has a fancy name-structured products. These invest part of the money in debt and partly in high-risk products like derivatives. All these years, the core of structured products was Nifty futures and options. But wrong calls there too have led to large losses in Nifty-based structured products sold to HNIs. So, now, structured products have another hot product at their core, one that never fails to attract Indians: gold.

These products aim to replicate the performance of gold while promising to keep your money safe. They are called gold-linked debentures. How is your capital safe? Almost 80% of the money is invested in a fixed income product in such a way that on maturity the invested part (say 80%) and the plus they get on the interest equals that of the principal. The rest 20% or so is put in gold. Not physical gold but gold futures whose value is dependent on gold.
Many investors are enticed by the investment proposition offered by these products-safety of capital and upside of gold. It is a sham.

Most investors believe that structured products are designed in a manner that equips them to deliver superior returns. Besides, they also consider them to be less risky. Structured products are not as simple as they are usually made out to be; they are quite complex. Since they use a blend of investment strategies, it is difficult for most investors to understand the strategy driving the risky part. Expectedly, investors aren't aware of the situations when the strategy might fail to deliver.

We had many instances where people have made huge losses investing in these products. A major example of this is Aditya Birla Money, the brokerage arm of Aditya Birla Group which suffered over Rs100 crore in losses on its 'Options Maxima' strategy for HNIs in 2010.

The HNI clients had put money in the so-called structured product called Options Maxima product, under the strangle strategy. The scheme promised returns of around 1%-1.5% every month based on the arbitrage opportunities through this activity, which ensured what was considered a very fair 12%-15% return annually.

A strangle involves purchase or sale of particular option derivatives that allow the holder to profit, based on how much the price of the underlying security moves, with relatively minimal exposure to the direction of price movement. It was considered "safe." Apparently, the bets were yielding good returns for both the dealer as well as the investors as long as the Nifty was moving in a range. The bets went wrong after the sharp up-move in the index in early September 2010.

The same thing may happen with these gold futures on MCX. Gold futures can be bought with a 12% margin and losses are marked to market. This means that any movement in the price of gold will increase or decrease the margin and profit/loss accordingly. Thus if the margin requirement is 12% and the prices of gold moves down by 12% your whole capital gets wiped out.

Terms like derivatives, paired trades and equity-linked debentures, among others, have enticed a lot of investors into investing in these products. A strong marketing pitch by fund houses combined with fancy terms/investment strategies leads them to believe that structured products are superior and investors are dumb if they don't get into such complex ideas yielding higher profits. However, there are certain elements that investors need to consider before investing in structured products. Some of the structured products claim to perform across market conditions. Too good to be true, isn't it? This is simply because these products have not even gone through enough back testing, to guarantee the investor any return of principal or performance.

Investments in instruments like structured products should be made only after there is a clear understanding of its investment proposition, risks involved and the returns projected. If the investor can unravel the structure and can take on the risk for that additional return, then he can consider investing in them. To deal with it, the first question an investor has to ask is: what is the maximum loss possible? If he is told, "loss is ruled out, your capital is protected", the salesperson is possibly lying.

These products have come in the market in waves and have failed to succeed at all times. They come and go and each time they enter with a core product that is hot at the moment. And this time it is the yellow metal. But even if they inflict losses each time there seems to be a market for them always. Each time there is a new set of gullible wealthy investors.

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