SPA-2008

Structured Products News from SPA

Wednesday, June 11, 2008

Investopedia: Structured Retail Products Too Good To Be True?

by George D. Lambert
(Contact Author Biography)

Structured retail products promise a return tied to a portfolio's earnings and guarantee you'll get your original investment back - regardless of what happens to the market! And some even offer to pay double or triple an index's return. You might wonder whether there's a catch. Can there really be reward without risk? It would seem so - that is, until you look beneath the surface.

The financial institutions issuing structured retail products might invest in one or more stock indexes. For instance, these could include the DJIA, the S&P MidCap 400 Index, the S&P SmallCap 600 Index, the Dow Jones EURO STOXX 50 Index, or the Nikkei 225 Index. Some even offer products that are tied to a handful of stocks in one industry, such as the energy sector.

Who sells them? Several banks and brokerage firms offer structured retail products, each with a unique acronym, but the concepts are basically the same: If the underlying index or stock in the portfolio does well, you'll get a piece of the return. On the other hand, if the market tanks, you're assured to get all of your money back. Plus, they might throw in a little interest.

How They Work

One bank, for example, has a $1,000 five-year note that pays at maturity the greater of two amounts:

Your principal plus a 5% total return (0.98% annual), which comes out to: $1,050

A piece of the underlying portfolio's or index's return. The payout includes dividends, but it's credited quarterly and your account is charged for any losses in the index. At the end of each quarter, you'll get credit by calculating the:

Ending Level - Starting Level
______________________
Starting Level


Then, the level is reset for the following quarter. Your total return is the compounded value of the 20 (five years x four quarters) quarterly returns. The most you can make with this particular bank's product is 7% per quarter.

Compounded, that comes out to 31% a year - not too shabby. But what if the market doesn't go up every quarter during the year?

[Theoretically assume] the market had a 6.59% gain for the year. However, because of the way the earnings were credited with this bank's structured retail product, you would have actually lost 7.55%! You wouldn't have this problem, though, if the market stayed on a steady, upward course throughout the year.

How does the issuer protect your capital?

Since the financial institution promises to return your principal, it has to hedge against a drop in the underlying index. As a hypothetical example, imagine you invest $1,000 in a three-year structured retail product that is linked to the DJIA. The institution might put $865 of your money into a three-year zero-coupon bond that is set to grow to $1,000 at maturity. Therefore, if the index drops in value, the institution has the money to meet its obligation to you. Next, the institution uses the remaining $135 to buy call options on the DJIA. That way if the index rises, it'll get both the initial principal ($1,000) and profits related to the index's growth to share with you. But if the index falls, the call options will not be exercised and the investor will still have his initial $1,000.

Other Versions

There are products out there that have different payout caps, such as 90% of the S&P 500's return. You might also run across structured retail products that offer to pay a return at maturity that is a multiple of their underlying market index's return. However, the gains might be subject to limits, such as no more than a 30% total gain over two years, so don't expect to make a killing.

Furthermore, you might have to share in a portion of any decline in the index; therefore, you could get back less than your initial investment. (To read more about capital gains, see Capital Gains Tax Cuts For Middle Income Investors and A Long-Term Mindset Meets Dreaded Capital-Gains Tax.)

How They're Taxed

The tax rules for structured retail products are similar to those of zero-coupon bonds. Therefore, even though you don't actually receive the guaranteed interest each year, you'll pay annual tax on it at your ordinary tax rate (up to 35% federal). At maturity, if the account is up, you'll get another tax bill on the additional earnings.The RisksStructured retail products carry a few risks. Among them:

Neither the FDIC, nor any other government agency, guarantees the products, regardless of whether you bought them from your bank. They are unsecured obligations of the issuing financial institution. As a result, if the issuer goes down the tubes, your investment could, too.

Structured retail products are not redeemable prior to the maturity date. You can try to sell on the open market, but the price you get may be influenced by many factors, such as interest rates, volatility and the current level of the index. As a result, you might end up with a loss.

You won't receive any interest while you own the account.

Conclusion

Structured retail products are a little like certificates of deposit tied to stocks - you get some upside potential with a safety net in case the market takes a dive. Plus, whenever interest rates rise, the minimum promised returns might be an attractive alternative to traditional fixed-income investments, such as bonds. Nevertheless, there are restrictions, so make sure you understand the prospectus before you invest. Otherwise, you could be horrified to suddenly discover that you own an investment that goes down in an up market, and that you may not be able to sell it without taking a loss.

by George D. Lambert, (Contact Author Biography)

George D. Lambert is a freelance financial writer with more than 20 years of experience in the financial services industry. He has worked as a Certified Financial Planner, a Certified Divorce Financial Analyst and an arbitrator for the NASD, NYSE and AAA. George is approved by the Florida Licensing Education Section to instruct life, health and variable annuity courses. To read more about George and his services, visit www.e-financialWriter.com. Also be sure to check out his latest book, "A Boomer's Guide To Long-Term Care".

NASDAQ-SPA June 11 Meet-the-Press Event at NYC MarketSite



Panel members from the Second Annual NASDAQ-SPA Media Event on June 11, 2008 (left to right): Matt Ginsburg, Wells Fargo; Keith Styrcula, Structured Products Association; Karen Fang, Goldman Sachs; Philippe el-Asmar, Barclays Capital; Scott Mitchell, JPMorgan; John Radtke, InCapital; and Richard Keary, NASDAQ-OMX.

Special thanks to NASDAQ's Wayne Lee for the press availability. Photo by Rob Tannenbaum.

Structured Products Confused with CDOs - Investment News

By Dan Jamieson, June 11, 2008

NEW YORK - Sales of structured products continue to grow despite the fact that they are often confused with subprime-tainted collateralized debt obligations, said Keith Styrcula, chairman of the Structured Products Association at a media briefing today in New York.

“Half of all news alerts talk about CDOs as structured products,” he said. “They're not CDOs; they're not subprime.”

Ratings agencies have added to the confusion by calling some of their CDO-ratings groups “structured-products groups,” Mr. Styrcula said.

The confusion has also caused some compliance officers at brokerage firms to wonder whether investors are being sold mortgage-backed bonds, he said in an interview.

Sales of structured products are expected to reach $120 billion this year, surpassing the record $114 billion in sales in 2007, according to the Structured Products Association.

In 2006, sales were just $64 billion.

Retail buyers have been increasingly interested in products with downside protection and strong credit ratings, according to industry participants on a panel at the briefing.

About 16% of sales this year have been in commodity-linked products, up from 8% last year, said Philippe El-Asmar, managing director and head of structured-product sales at Barclays Capital, the New York-based investment-banking division of London-based Barclays Bank PLC.

To see the original version of the article, click here.

The Fever for Structured Products -- Registered Rep.

By BRIAN WARGO, Registered Rep. Magazine
(Originally published March 1, 2008)

Long a Favorite of Investors in Europe, structured products are rapidly gaining popularity in the United States. Last year, $114 billion in structured products were issued in the U.S., according to the Structured Products Association.

That's a 78 percent jump over 2006 — and dwarfs the $32 billion in structured products issued in 2004. Previously the sole purview of sophisticated high-net-worth investors in the U.S., they have begun filtering into the mainstream. The retail market bought some $58 billion — or about half — of the structured products issued in 2007.

Structured products combine financial instruments, typically bonds and derivatives, into a package that allows investors to bet on the direction of stocks, bonds and other investments. They are used to both hedge and to speculate, and typically pay an interest or coupon rate substantially above the prevailing market rate. Many of them also cap or limit upside returns, particularly if principal protection is offered.

One reason demand has picked up so much over the last three years is that a number of new financial institutions have entered the market, says Kumar Doraiswami, managing director and head of sales for Natixis Capital Markets. There are 30 active issuers today, up from 10 five years ago.

That has improved liquidity and helped to cut transaction costs — two issues that have long concerned investors and advisors, he says. The increased number of offerings, and the accompanying press coverage, has also helped generate greater awareness of the benefits and risks of the (relatively new) instruments, says Philippe El-Asmar, managing director and head of investor solutions for the Americas region for Barclays Capital.

El-Asmar believes structured products will continue to win greater appeal, particularly those that give investors exposure to attractive but risky markets, such as emerging equities or commodities, but protect them on the downside. Those frustrated with a 3.5-percent return on bonds, for example, may appreciate a product that protects their principal while giving them 80 percent of the upside in the market, he says.

Current market conditions could also enhance their appeal. Randy Pegg, executive vice president of Colorado-based Fixed Income Securities (FIS), says the U.S. structured-product industry witnessed tremendous growth during the market correction of 2000 to 2001 as more investors realized they could protect their downside, yet remain invested for some upside.

The same reasoning may now be at play, according to Pegg. “We have experienced increased demand with the recent market sell-off,” he says. “Investors have learned that to make money in the market, you must be in for the up days. When they know they have principal protection, investors can stay invested longer and still sleep at night — especially during turbulent times.”

For the full article, please click here.