I am featured in an article on a new structured product from Deutsche Bank. The product is based on their commodity index. The product offers 150% to the upside so it is a leveraged product. They are trying to get folks who think commodities are going to continue their upward movement. The matures in three years so this is the investment horizon an investor must have for commodities.
Emma Trincal, who wrote the article, was very thorough and professional, but I think she could tell that I don’t like structured products. And, I wasn’t afraid to show it. She handled it diplomatically despite the fact that she earns her living writing about structured products.
For those who don’t know, a structured product is produced by a financial company. It is fully backed by the underlying company so there is a risk the product could implode if the financial company does. The structured product provides a contract that lays out how the product functions. Usually, these products are tied to an index or individual stock. Often times, these are sold as a risk management tool.
For example, you may buy a structured product that tracks the S&P 500. However, the product may guarantee that you won’t lose money. In return for the loss guarantee, you only get a percentage of the upside. This sounds great to a lot of people: no chance for loss and some upside. But, I don’t like structured products because they have company risk, as previously mentioned, very high costs, illiquid (tough to sell if you need to), and opaque (hard to understand). I certainly wouldn’t use these if they aren’t used to mitigate risk as this Deutsche Bank product does.
I often recommend to investors that if they want a structured product that they invest like the underlying company. This way the investor can still mitigate risk, but the investor gets the full upside, rather than a cap. Take the S&P product described above as an example. The financial company probably buys a call option on the S&P that corresponds to the time period of the structured product (six months, one year, three year). That consumes about 10% of the capital. With the other 90%, the financial firm buys some sort of bond instrument (Treasury, sovereign debt, CD). Essentially, these firms take a simple idea and market it as a unique solution. All the while, they charge egregious fees to do so. Brilliant! Feed on people’s ignorance.