Money managers hardsell tailor-made plans to HNIs

Source:FC: Prashant Mukherjee Apr 07 2010 , New Delhi

Structured notes are capital protection products with varied options
Structured notes are emerging as a new investment opportunity with wealth managers wooing high
net worth individuals (HNIs), including non-resident Indian (NRIs), to invest in these products with the lure of higher capital guaranteed returns.
Structured notes are financial products that appear to be fixed income instruments, but contain embedded options specific to the investor. These options may be 'plain vanilla' or they may be highly leveraged exotic options. Each instrument is unique. Some products offer capital protection, therefore one doesn't lose their original investment even if the value falls.

“These products are complex in nature and a very limited number of clients understand such products. But we have seen big volumes in these types of products and going forward, once the debt market develops, we may see momentum picking up in these as well,” said Anil Chopra, chief executive officer, Bajaj Capital.

Several wealth management firms and foreign banks are devising alternative investment options such as structured products with a capital guarantee, exchange-traded notes (ETNs) for HNIs and NRI clients at a time when returns from investments in equities have turnedvolatile.

Even the issuers are not exposed to much risk in issuing these instruments. Some of the schemes that are offered by companies are JP Morgan 10 years callable constant maturity swaps (CMS), Barclays hybrid linked notes and deposits, among others.

However, structured notes were not instruments such as collateralised debt obligations and structured investment vehicles that got a beating during the global credit crunch and subprime mess. Structured notes are financial instruments that combine derivatives with equity or fixed income, resulting in customised risk and return profiles.

Now how does it work and what benefit does an investor get? Suppose you invest Rs 100 in a five-year CMS callable structured note issued by X company that carries a coupon rate of 7 per cent per year for a five years. Now, say the issuer gives you a two times leverage on your investment, which means you invest Rs 100 and the company will invest Rs 200, hence the total amount invested will be Rs 300. Now ideally, you should have received only Rs 7 per year because you invested only Rs 100, but because of the leverage you tend to receive Rs 21 per year (Rs 300 X 7 per cent).

CMS is the benchmark exchange rate. The Libor rate more than one year is known as CMS.

The customer can maximise returns by taking a leverage option from the bank. The coupon will be paid out quarterly for the number of days the five-year CMS stays within the range of 0 to 7 per cent. The extra amount of leverage will not come free of cost. The bank charges 1 per cent plus one-month Libor per year because the interest on the leverage amount that is deducted on a monthly basis from his account.

“Structured notes may also be used by investors to expose their portfolios to asset classes or markets in which they cannot directly invest due to investment mandates and regulatory restrictions.

Due to the fact that the note looks, and smells like a bond, with a credit exposure that makes it appear a solid credit, many investors utilise them to get involved with asset classes and receive higher returns with guaranteed capital,” a senior executive of Royal Bank of Scotland, Dubai told Financial Chronicle on the condition of anonymity.
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