Structured products in family office wealth management


Summary

Structured products should be considered as a building block of a well-diversified family office investment portfolio to facilitate appropriate growth and preserve multi-generational wealth.

Introduction

A structured product is a pre-packaged, financial product based on a single security, a basket of securities, options, indices, commodities, fixed income, currencies, and derivatives. These investments aspire to provide investors with targeted investment returns within specified risk tolerances.

Structured products normally consist of three main components: a bond that generates income, the underlying asset that generates investment returns, and a derivative strategy that provides protection against financial loss.

Despite the complexity of these financial instruments, a structured product provides a unique solution to the challenge of preserving and growing multi-generational family office wealth. When designed correctly, these instruments allow families access to growth assets, to ensure longer term inflation, beating returns, together with a degree of principle protection in case of adverse market conditions.

Categories of structured products

The four most popular types of structured products, in order of increasing level of risk, are: capital protection, yield enhancement, participation and leveraged structured products.

Advantages

Structured products have many benefits including the provision of capital protection, delivering predictable results and offering flexible investment solutions.

Capital protection

Structured products offer investors the possibility to invest for a specified return while simultaneously offering a predetermined level of capital protection.

Predictable results

Structured products are very predictable investments, as all the conditions that determine the outcome are set in advance. The issuer, underlying asset, protection barrier, coupon size, etc. are all known qualities beforehand. The only unknown variable is the eventual market-behaviour of the underlying reference asset.

Flexibility

Some structured products offer investment returns with highly limited principal risk. Other products offer a high investment return, even in range-bound markets. It is possible to construct virtually any kind of structured products using the multitude of financial instruments available.

Disadvantages

There are some potential disadvantages to structured products that must be considered. These include: credit risk of the issuing counterparty, lack of liquidity for longer dated products, and pricing transparency.

Credit risk

A structured product involves a loan to the issuer of the products. One of the most significant disadvantages of structured products is the credit risk that an investor must undertake if the issuing financial institution forfeits on its obligations. This adds a layer of credit risk on top of the underlying market risk.

Early termination

Most structured products are designed to be held for their full term. If it becomes necessary for an investor to the sell the structured product before maturity, they will receive the value of the investment in accordance with the prevailing market conditions, less any associated selling costs and transfer taxes as applicable. Certain structured products can only be unwound and sold on specific dates.

Pricing transparency

Most structured products come with a term sheet, summarising the terms and conditions. This term sheet explains how the structured product works and sets out all its features. The pricing mechanism is explained by a mathematical formula, known as the redemption formula.

Conclusion

Structured products should be considered as a building block of a well-diversified family office investment portfolio to grow appropriately and preserve multi-generational wealth. These investment products can provide inflation beating returns and a degree of principle protection, with a high likelihood of success.



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