Understanding Structured Products: Opportunities, Risks, and Differences from Other Common Investment Vehicles

Many investors are familiar with common investment vehicles like stocks, bonds, ETFs, ETPs, and mutual funds, but comprehension ends as soon as terms like “barrier reverse convertible,”  “capital protection product,” or “knock-out certificate” come up. They are designations from the world of structured products, but there is a clear logic behind this seemingly complex vocabulary.

Structured products combine conventional assets (such as stocks, bonds, currencies, or commodities) with derivative components like options or swaps. They pursue a predetermined payoff outcome. Investors in structured products do not have to compose the individual instruments or purchase the underlying assets themselves.

Derivative components alter the risk-return tradeoff of an investment and render different payoff profiles possible. They are used to replicate specific market expectations in order, for example, to enhance participation in upward movements or to obtain contingent protection in the event of downward movements.

A derivative component is always based on the price performance of an underlying (reference item), which can be an individual stock, a basket of stocks, an index, a currency, a commodity, or an interest rate.

Depending on the type of product, a term to maturity can range from a few months to several years. The Swiss Structured Products Association (SSPA) distinguishes four main categories:

There are also hybrid and customized structured products such as ones featuring multiple underlyings or exotic barriers, for example.

The issuer of a structured product is the financial institution that originates and sells it. Banks and specialized issuance platforms are the predominant structured product issuers in Switzerland.

In legal terms, exchange-traded structured products are securitized bearer bonds. This means that investors acquire a claim against the issuer. The value of a structured product thus also constitutes a credit risk.

Credit risk plays an important role: since investors hold a claim against the issuer, the repayment depends not just on the market performance, but also on the issuer’s solvency.

It therefore can be sensible to compare the credit ratings of different issuers. The Swiss Structured Products Association (SSPA) regularly publishes an overview of the largest structured product issuers in Switzerland, a group that includes UBS, Zürcher Kantonalbank, Vontobel, Julius Bär, Raiffeisen, and Leonteq.

Any investor in a structured product should scrutinize its terms and conditions and should apprehend how it behaves in different market scenarios.