written by UBS Editorial Team
The current investment backdrop is challenging – expected returns in bonds are low but risks in equities are high. What investors can do, however, is to take advantage of structured products.
Here are some of the things about structured products you need to know.
Why do I need structured products in my portfolio?
There are many situations where investors would find structured products useful. For example, when investors are fearful of current equity market risks but looking for higher returns than those on offer in bonds and cash, or when investors are looking for income at a time of low cash and bond yields but expecting only limited returns in equities.
There are also times when investors are looking to increase long-term strategic allocation to equities but are worried about near-term market timing.
In fact, structured products can be effective risk management solutions if integrated strategically in a diversified portfolio, according to UBS CIO Global Wealth Management.
What are some of the strategies structured products employ?
Let's start with the strategy for protection. While investors are currently nervous about their equity holdings or investing further into equities, reducing exposure to equity markets may mean reducing the chance to protect wealth from inflation. This is when the protection strategy comes in – it allows investors to retain exposure to equity markets, while offering partial or full downside protection.
How does it work?
Protection strategy typically combines exposure to equity markets with some level of protection of the capital, making such an investment more conservative compared to holding equities outright. Such exposure can be linked to either, or both, of the upside and the downside of equity markets – so investors can participate in the positive performance, and/or generate positive returns even when equity markets correct.
Are structured products useful in increasing returns?
The most common yield enhancing strategy involves taking on exposure to potential downside risk in equity markets in exchange for regular income.
Among the most popular strategies are known as put writing – it can be structured into notes such as Reverse Convertibles or Barrier Reverse Convertibles linked to broad based equity indices or also single stocks.
CIO believes that replacing a portion of equity exposure with put writing would have improved most of the key performance characteristics of a portfolio – lower volatility, lower maximum drawdowns, and improved portfolio diversification effects.
How else can structured products help me?
Investors can find it difficult to move from cash into equities due to short-term market uncertainty or concerns about the current valuation of the stock market. Structured products can help investors increase their exposure to equities, and can be thought of as "being paid to wait for an opportunity to buy".
For example, physically settled put writing would allow investors to earn income while they wait to buy stocks at prices below current levels.
This means that there is no need to time the market, there would be higher returns than cash over the long term, and having lower volatility.
These all make sense. But what's the caveat?
Different strategies work in different markets. Protection strategies delivered superior performance to equities during bear markets, whereas yield enhancement strategies tend to perform relatively better during periods of range-bound performance.
Ultimately it comes down to investor's short- and long-term investment objectives, and how structured products are positioned in the portfolio.
For more, read CIO's report – Structured solutions for an uncertain world.