How Structured Funds work


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How Structured Funds work

Structured products remain popular because of their defined returns and ability to produce tailored risk profiles and targeted investment opportunities.

Typically an investor will buy a note, plan or deposit with a given maturity and an exposure linked to certain underlyings, backed by a single issuing investment bank. The accepted rules and practices of sound portfolio management apply to structured products as much as any other investment and so an investor would naturally seek over time to acquire different products diversified by issuer and underlyings.

Buying individual products

However some of the key advantages of structured products lie in the fact that target income or participation levels are clearly defined giving precise exposure to the underlying assets. Investors can easily relate to the yield or return prospects together with the key conditions such as finishing above the required initial or defensive levels as well as understanding what is required to avoid poor outcomes such as barrier breaches.

It could be argued that such properties which apply to a single product represent some of the strengths of this investment class. Weaknesses of “conventional” structured products from the adviser or distributor perspective include the regulatory burden that they attract in many jurisdictions together with the fixed term nature of each investment with the result that regular investment can be both burdensome and haphazard.

Going down the fund route

The structured products fund concept aims to solve many of these problems. Typically they act like regular open ended funds in familiar wrappers such as OEICS (UK), UCITS (Europe) and 40 Act in the US.

The first advantage of the fund construction is that it places the investment in a significantly easier regulatory context and allows for an open ended investment. Because the underlying investments are still structured products, challenges around pricing and liquidity may still exist compared to a traditional fund or ETF.

The second advantage is to allow for diversification by using more than one issuing bank, potentially a blend of underlyings and benefit from multiple investments to reduce timing risk. This will provide portfolio benefits that go beyond what a single product can do.

These features seem pretty compelling and therefore we might expect a large amount of investment into structured product funds. Despite some success stories it remains a niche sector for a number of reasons.

Pros and cons

Structured funds do provide a more general route into structured products and these could be used to harvest some of the long term benefits such as selling downside risk at barrier levels that have historically rarely been breached. This is the typical strategy of such funds to provide lower volatility returns requiring little or no equity market growth. Therefore structured product funds would be considered alternatives to “cash-plus” strategies such as managed funds and absolute return funds. As with any new fund a structured product fund will be judged primarily on its track record and performance against suitable benchmarks. It is undoubtedly possible for such a fund to demonstrate a decent performance over a long period of time.

However serious questions should be considered. Firstly such a fund will incur two sets of charges, the fund manager and the fees from the underlying structured products. Unlike a conventional fund there will be less transparency about the fee structure. Since such a fund will compete against Smart Beta style ETFs questions should be asked around the transparency of fees, the clarity of the investment strategy and characteristics, and the nature of any counterparty risk or collateralisation.

UK fund examples

Examples of structured product funds in the UK include Atlantic House Defined Returns Fund, Mattioli Woods Structured Products Fund, Valu Trac SG UK Defined Return Assets Fund and the Lowes UK Defined Strategy Fund.

Conclusion

In summary structured funds provide an interesting bridge between conventional structured products and Smart Beta and algorithmic funds. However the rationale and efficiency of such a choice should be clearly thought through together with proper explanation and positioning to the end investor.

Tags: Algorithms Investment Structured Edge

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