Structured Products

Structured products: build in downside protection

Structured products are pre-packaged fixed-term investments that provide private investors with easy access to offshore equity and commodity markets, with a pre-defined risk and return profile over a pre-defined investment period. They also provide varying levels of downside protection with adequate upside participation.

Our GraySwan investment team has continuously been researching various structured product options to complement our clients’ traditional offshore equity and commodity investment portfolio holdings.

We have a dynamic menu of such products which our team has already approved via their robust research process, which is updated every month. In addition, we now have the capability to tailor-make structured products for our clients with very specific needs.

In the past, it was necessary to rely on third-party providers who offer these products on an ad-hoc basis. We found that most of the products were not suited for our clients and the infrequency of access to those products that were fit for purpose was also not ideal. Our investment team has found a solution to proactively and continuously offer structured products to our clients. Via a world-class offshore trading platform, we now provide access to bespoke structured products tailored to our clients’ specific needs. But more on that later.

Market uncertainty remains high after an unpredictable 2022 followed by a very strong equity market recovery over the past month. Timing equity market exposure is challenging, and political and economic uncertainty only adds to the difficulty.

We believe, optimally constructed offshore structured products are an appealing investment option as they reduce the risk of market timing and can provide partial or full capital protection, allowing investors to obtain exposure to equities and commodities in a risk-controlled manner.

More about structured products

Structured products typically have a term ranging from three to five years, although shorter or longer terms are also possible. Tax implications will vary depending on the term of the investment, with capital gains tax applying unless the investor surrenders early, in which case it may be taxed as income.

The issuer of structured products uses asset classes such as equities, bonds, and derivatives to structure the performance and risk profile for the investor, also known as the risk-return payoff profile. This risk-return payoff profile refers to the balance between downside protection and upside participation. Structured products are offered in both offshore and local currencies, linked to offshore assets.

For conservative investors, a higher level of capital protection with a corresponding lower participation in the upside of the markets may be most suitable, while more aggressive investors may prefer less capital protection and a higher level of growth participation, with the possibility of leveraged returns. 

Wrappers

Structured products can be invested through vehicles such as sinking funds or endowments, which provide tax and estate duty benefits, including:

  • Investment income and capital gains tax paid within the investment, on behalf of the investor, at a capped, effective income tax rate of 30% and capital gains tax (CGT) rate of 12% respectively.
  • Beneficiary nominations avoid the complications of potential offshore inheritance tax and executors’ fees, although the value will still form part of the investor’s South African estate for estate duty purposes.
  • In a life wrapper, the value is protected from creditors after the investment’s first three years have passed.

Potential risks

Investing in structured products comes with the following risks:

  • Counterparty/credit risk refers to the financial institution’s ability to keep its promise of guarantee, capital protection, or enhanced return at the maturity of the structured product. Such risk can, however, be managed via a collateralised product option if the investor does not wish to be exposed to counterparty/credit risk.
  • Liquidity risk as most structured products are designed for a specific period, and full benefits can only be realised if the investor stays invested until maturity.
  • Structured products do not pay dividends.

Available options through GraySwan

As previously noted, we have traditionally relied on various investment platforms and product providers to offer structured products throughout the years. Our investment team would then conduct analyses of these products before determining which of these products meet our due diligence and investment criteria after which our financial advisors will discuss these with our clients if and where they meet the performance objectives and risk budget of each client.

While we will continue to utilise these external products in the future, we now also have the capability to proactively construct tailor-made structured products for our clients. In this regard, we have established a partnership with a Swiss-based platform with an investment-grade credit rating which is three levels higher than South Africa’s top-rated banks.

We have the flexibility to select any level of capital protection, along with a guaranteed or non-guaranteed investment return, linked to a specific underlying offshore asset. The range of options available is extensive and includes various indices, instruments (i.e. exchange-traded funds and actively managed funds), single stocks, or a combination thereof.

For illustration purposes, examples of these products include outperformance certificates, bonus certificates, and capital protection certificates. The tables below display the final value of the underlying offshore asset on the left, at the end of the investment period (which is three years for all of these examples), versus the final redemption value for the investor:

Example 1: Outperformance certificates

This certificate offers a 200% participation in the positive performance of the underlying offshore asset. The performance is capped at 125.11% of the initial level. This means that even if the underlying offshore asset returns more than 25.11% during the investment term, the investor’s maximum return would be 50.22% (25.11% return x 200% participation).

On the downside there is only a 50% participation, meaning that if the underlying offshore asset loses 10%, the investor only loses 5%, etc.

(Click to enlarge) *Please note that these examples are based on a very specific set of underlying offshore assets and other factors to create these specific pay-off profiles.

Example 2: Bonus certificates

This bonus certificate offers a bonus level of 120% if the underlying offshore asset closes above the barrier level of 54% at maturity. Thus, at the end of the investment term, the underlying offshore asset could have lost up to 46% in value, and the investor will still earn a cumulative 20% investment growth. Also, on the flip side, if the underlying offshore asset grows by 20% or more, the investor’s maximum possible return is capped at 20%.

If the asset loses more than 46% (thus crossing the barrier level of 54% of the initial value), the investor will partake in the full loss.

(Click to enlarge) *Please note that these examples are based on a very specific set of underlying offshore assets and other factors to create these specific pay-off profiles.

Example 3: Capital-protected certificates

The capital-protected certificate offers a 122.89% participation in the positive performance of the underlying offshore asset, where the performance is capped at 130% of the initial level. This means that should the underlying offshore asset return, for example, 20% at maturity, the investor will earn 24.58% (20% x 122.89% participation).

The return is, however, capped at 30%, meaning that if the underlying offshore asset returns 30% or more, the investor’s maximum possible return is capped at 36.87% (30% return x 122.89% participation).

The capital is also fully protected, no matter how much value the underlying asset loses over the investment term.

(Click to enlarge) *Please note that these examples are based on a very specific set of underlying offshore assets and other factors to create these specific pay-off profiles.

Costs and fees

Costs and fees are fully priced into each structured product. The issuer of the product embeds its cost within the pay-off profile. Therefore, the promise made by the issuer is already net of their cost. Other costs such as the implementation and monitoring fee are disclosed upfront to the investor. 

Minimum investment

The minimum amount to invest in any of these tailor-made offshore structured products is $25 000. Such minimum has been set as we typically recommend clients to invest offshore via tax-efficient life wrappers and the minimum for these investments is also $25 000. Minimum investment amounts for products from other providers, which we will also continue to utilise, may vary.

If and where clients’ monies are not yet in foreign currency we can assist with the foreign exchange conversion at low institutional rates rather than retail rates. 

Conclusion

Structured products can be designed to form part of any well-balanced and diversified investment portfolio.

During uncertain times capital protection of any kind is a sought-after benefit. This, coupled with the possibility of an enhanced investment return, is an attractive combination.

Our investment team not only continuously analyses the various structured products available in the market but we now also structure such products ourselves via an offshore investment platform. Our investment team has constructed a menu of various offshore structured products which are fit for most investors. Our financial advisors then proactively advise our clients to consider such if they find any option on the menu suitable to their risk profile and performance objectives.

Our ability to analyse and research the various structured products as offered by the market as well as our own ability to tailor-make such product options provides our clients with the freedom of choice.