Challenges of structured products

Structured products, often viewed as sophisticated financial instruments, come with a set of challenges that can complicate their use and understanding. These challenges include:

Complexity

Structured products are typically composed of various underlying assets, such as equities, bonds, interest rates, or commodities, often combined with derivatives. This complexity can make it difficult for investors to fully understand the product structure, the associated risks, and how market conditions will impact performance.

Lack of Liquidity

Many structured products are not traded on public exchanges, leading to limited liquidity. Investors may find it difficult to sell their investments at favourable prices, especially in volatile market conditions. This lack of a secondary market can result in having to hold the product until maturity, even when market conditions have changed unfavourably.

Credit Risk

Most structured products are issued by financial institutions, which means they carry the credit risk of the issuer. If the issuing institution encounters financial difficulties or defaults, investors may suffer significant losses, regardless of the asset performance. This inherent risk underscores the importance of evaluating the issuer’s creditworthiness.

Limited Transparency

The pricing of structured products can be opaque, as they often involve proprietary models and assumptions. Investors may face challenges in accessing or understanding the detailed information that drives the product's valuation. This opaqueness can lead to difficulties in assessing whether the product aligns with their investment goals and risk tolerance.

Market Risk

Structured products are inherently sensitive to market movements. Changes in interest rates, stock prices, or other market factors can significantly alter the expected returns. For example, if the underlying asset's performance does not meet predetermined levels, investors may receive reduced payouts or even face capital loss.

Regulatory Considerations

The regulatory environment for structured products can be complex and varies by jurisdiction. Investors must be aware of the specific rules and regulations that govern these products, as non-compliance can lead to legal challenges and potential financial repercussions.

Suitability

Given their complexity and tailored nature, structured products may not be suitable for all investors. Assessing whether a structured product matches an investor's financial situation, investment objectives, and risk tolerance requires careful consideration. Misalignment can lead to dissatisfaction with product performance and unexpected losses.

In summary, while structured products can offer unique opportunities for investment diversification and potential return enhancement, they also present significant challenges that necessitate thorough understanding and careful consideration before investing.