What are structured investments?
Morgan Stanley Wealth Management06/30/22
Summary: Structured investments can enhance a traditional stock and bond portfolio to address specific investment objectives within an overall investment plan—but they come with unique features and risks.
Structured investments (also called “structured products”) typically combine a debt security or a certificate of deposit (CD) with exposure to other underlying asset classes such as equities, commodities, currencies or interest rates. In some instances, exposure can be linked to two or more underlying asset classes, which are often referred to as hybrid offerings. These products are typically offered by investment banks and come in a variety of forms, including senior unsecured notes of the issuer and CDs.
For example, a structured investment may be issued as a $1,000 CD that expires in five years. Rather than traditional periodic interest payments, structured CDs typically offer a potential supplemental payment at maturity based on the performance of an underlying asset, such as the S&P 500® Index.
Investors can use these products to: express a market view (such as bullish, bearish, or market-neutral); complement an investment objective (such as capital appreciation, income, or speculation); hedge an existing position; or gain exposure to a variety of underlying asset classes.
While there are a range of different structured investments that can be linked to various asset classes, in general these products share a few common characteristics:
- A specified maturity date or “term”. This may be as short as three to six months or as long as 15 to 20 years. Investors should consider the maturity of the offering based on their own view of the markets and their anticipated future income and liquidity needs.
- Formula-based returns. Returns are based on specific formulas that are tailored to a particular market outlook or market view. Investors know from the outset how the performance of the underlying asset will determine their potential return or potential loss, provided that the investment is held until maturity. If sold prior to maturity, the value of the securities could be significantly less than the original investment.
- The potential to generate outperformance. Structured investments can be designed to potentially generate returns in excess of a specific benchmark within a range of performance. Outperformance strategies, however, are subject to significant risk of loss of principal.
- Credit risk. All payments on structured investment products, including any repayment of principal at maturity, are subject to the issuer’s credit risk.
Know the risks
Structured investments can help investors looking to meet specific financial goals or diversify a portfolio, but their complexity can mask potential risks. Here are some important considerations:
- Structured investments are complex and not like ordinary debt securities. Structured investments are complex and involve risks not associated with an investment in ordinary debt securities.
- All payouts depend on the structure and the underlier. Structured investments have a variety of structures and may be linked to an even wider variety of underlying assets, each of which will have its own unique set of risks and considerations. All payouts will depend on the structure and the performance of the underlier. Your return, if any, may be less than the amount that would be paid on an ordinary debt security.
- Potential loss of principal. Depending on the terms, a structured investment may result in the loss of some or all of your principal. In addition, you may receive significantly less than the stated principal amount if you sell your investment prior to maturity.
- Usually no interest. Unlike ordinary debt securities, structured investments usually do not pay interest. For those that do, any payment of interest is typically dependent on the performance of the underlier.
- Upside participation may be limited. Appreciation potential or participation in the underlier may be limited. The terms of the investment may limit the maximum payment at maturity or the extent to which the return reflects the performance of the underlying assets.
- Not equivalent to investing in the underlier. Investing in a structured product is not equivalent to investing directly in the underlier or its components (for example, no dividends or voting rights for structures linked to stocks). As a result, any return will not reflect what you would realize if you directly owned shares of the underlier or its components, and received the dividends paid or distributions made on them.
- The market price may be influenced by a variety of unpredictable factors. Some of these factors include: (i) changes in the value of the underlier, (ii) volatility of the underlier, (iii) the dividend rate on the underlier, if any, (iv) changes in interest rates, (v) any actual or anticipated changes in the issuer’s (and the guarantor’s, if applicable) credit ratings or credit spreads, and (vi) the time remaining to maturity. Generally, the longer the time remaining to maturity, the more the market price will be affected by these factors.
- Secondary trading may be limited. There may be little or no secondary market for a particular structured investment. Accordingly, you should be willing to hold any structured investment to maturity.
- The historical performance of the underlier is not an indication of future performance.
- The possibility of early redemption. Some structured investments are subject to early redemption, also referred to as being “called” early. Any redemption will limit the term of the structured investment to the specified redemption date. If a structured investment is redeemed prior to maturity, you might not be able to reinvest at comparable terms or returns.
- Potential conflicts of interest. The issuer of a structured investment and its affiliates (including the guarantor, if applicable) may play a variety of roles in connection with the structured investment, including acting as calculation agent (which is responsible for determining the values of the underlier and calculating the amount you receive upon early redemption, if applicable, or at maturity, if any), hedging the issuer’s obligations under the structured investment, and publishing research reports on the underlying asset. In acting in any of these capacities, the issuer, the guarantor (if applicable) and its or their affiliates are not obliged to take your interests into account, and their economic interests may diverge from your economic interests.
- Tax implications. The tax treatment of structured investments is complicated. You should consult with your tax adviser in connection with any investment in structured investments.
- Credit risk. All payments are dependent on the issuer’s (and the guarantor’s, if applicable) ability to pay. Structured investments are not secured obligations and you will not have any security interest in, or access to, any underlying assets.
Each structured investment offering has a complete prospectus with important information about its unique features and risks. Investors should carefully read the prospectus before purchasing, and be sure that they understand its features, underlier(s), payout scenarios (how the return is calculated), and risks.