Structured Financial Products

Good things never last long. They come in waves and leave behind unwanted wastes which are picked up by the concerned authorities. It strikes a note similar to the one drafted by the meltdown in the financial market. The investors as well as the governing bodies were swept completely away as the Wall Street succumbed to the 'Greed-is-good' culture. The global financial crisis burst on the scene in August 2007. The last 15 months witnessed over $600 billion of net worth written down by financial firms. This was the aftermath. This was, however, immediately preceded by an era that boasted of sophisticated business processes, leveraged transactions and structured financial products. This was the period when the dealing street woke up to the illusory phenomenon called financial engineering.

In these years, the financial markets were flooded by a number of Structured Financial Products which were readily lapped by both institutional and private investors. Although these securities are generally nothing more than a bundle of traditional securities such as bonds and stocks, and derivatives, they offered investors the opportunity to purchase securities that provided more complex pay-off profiles. Besides US, Germany represented an outstanding growth in offering these products to the retail market. Citigroup's YIELD (Yield Income Enhanced Listed Deferred Securities), Goldman Sachs JBWere's GLRs (Growth Linked Return Investments) and Macquarie's ALPS (Alternative Listed Protection Securities) are few examples of such leveraged products.

These products have made inroads in the Indian retail markets over the last one year. What seems remarkable about this product is that the time when it got launched. These products used to rule the US and other foreign markets when the yields on government bonds were high and the cost of buying index options were low, especially in consolidating market. The asset management companies would usually adopt the most conservative path that involved investing in government zero coupon bonds, which sold at a discount and paid zero interest, but gradually compound in value to mature at a higher value. This would get combined with index options to retrieve a bigger pay-off.

The product made a timely entrance in the Indian markets when the party for mostly over at the local bourses. A time when investors were looking at low risk options which would protect their principal amount at least. This however serves the purpose of the high net worth individuals as the ticket size for these products usually remain high. One can pull off this risk mitigating act by putting his investible surplus in to the zero coupon bonds and options strategically and save the asset management fees charged by the companies.

The structure remains same for most of these products as the pay-offs are devised in similar ways across the globe. However, these products can be designed in many ways and can combine the best of the commodities and the currency markets. But as of now, structured products are usually a blend of both the equity and the debt market. The type and levels of sophistication have a long way to go.

Debenture Premium: 2.5% of face Value
Face value: Rs10 lakh

Though it turns out to be an example of simple diversification of funds into time-tested investment avenues, it proves to be a lot more sensible than the products which came out as a result of the 'financial innovation'. If everything sounds perfect, then where's the catch. What made these products a nightmare for the investors? Well the hunky dory tale would meet an abrupt end once the yield on government securities lower or the options become costly. The US players who had launched such schemes substituted the government bonds with their own unsecured securities. This however was clearly mentioned in their disclosure. And it wouldn't have hurt much as long as the street delivered. But to the amazement of some, it failed miserably, flushing millions down the drain. Thus the lessons to be learned by the investor are the same, sounding as old as the art of investment itself: If it sounds too good to be true, it probably is.