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What is your take on Structured Products
Old 04-14-2007, 08:16 PM   #1
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What is your take on Structured Products

Based on comment in another post I began looking more closely are Equity Linked Notes, and other Structured products. These products have fairly complex terms and tend to be a combination of futures, options, bonds, etc.... THe actual makeup depends on the product.

They sell on the AMEX or NYSE (maybe others). They seem to be thinly traded and often trade at a premium or discount.

It seems that the popularity of these investments are increasing amoung individual investors. However, they seem fairly complex. Understanding the stated benefits of some of these notes seems straight forward, however understanding the downside (or traps) is a little more fuzzy.

It seems to me that these things appeal to people attempting to limit the downside.

It has occurred to me that one is doing the reverse of diversification when they buy these notes. The investment is usually offered by a bank. If the bank has problems, everthing in the investment is tied to that one company. Where as a mutual fund is spread across multiple companies. In other words, if a bank over extend too much, those notes could be at risk. It seems that these banks limit their risk exposure (size of the note offering), however as these things get more popular, some could get caught in a squeeze.

Do you use these products? What do you thin good idea or bad idea?
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Re: What is your take on Structured Products
Old 04-14-2007, 09:17 PM   #2
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Re: What is your take on Structured Products

I don't and probably won't. I have become increasing suspicious over the years of "financial products."

My advice is to not buy anything you don't totally understand. By this I mean everything. You need to know how, why and how much money you can make. You need to know how,why and how much money you can lose. You need to fully understand the financial organization that markets the product you are considering.

Also, a financial instrument that is thinly traded is probably thinly traded for a very good reason. The same can't always be said for heavily traded ones.
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Re: What is your take on Structured Products
Old 04-14-2007, 10:11 PM   #3
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Re: What is your take on Structured Products

I own DJP which is an "Equity Traded Note", so, I'd say I don't have a problem owning some of the more novel things (if you consider this an SP). Many of the people here are more sophisticated from the "average investor" that gets sucked into these things by an investment adviser though.

Also, being a contrarian, you could make the argument that the fact that some of these are thinly-traded gives you an advantage in it not being a very efficient market, but I dunno. You'd really need to understand the terms. Most of them are probably a very bad bet.


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Re: What is your take on Structured Products
Old 04-15-2007, 02:26 AM   #4
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Re: What is your take on Structured Products

From a basic POV any security is a structured product. At the level of the individual firm there is a structuring of its capitalization. The simplest is when the entire capitalization is made up of one class of equity securities- common stock. But many firms have "super voting stock"- a and b shares. An additional level of structure occurs when debt securities are issued. There may be secured debt as with mortgage bonds in the old utility or RR capitalizations; equipment trusts where a bond issue is backed by certain locomotives or airplanes; unsecured senior debt; subordinated debt and even convertible debentures. Any of these can have whatever terms and conditions the seller offers and the buyers accept- CPI linked notes, interest step-up notes, etc.

And don't forget warrants. Thus each firm can create the capital structure that it hopes will most cheaply give them the funding and flexibility that they feel is needed.

Moving away from the individual firm at the simplest level is the mutual fund. But these funds and ETFs are not necessarily so simple, as in the case of index tracking funds they may do it largely with derivatives, another structured product.

Royalty trusts are a structured product designed to get reserves off an E&P compnies books in return for cash and continued control of the asset. Same thinking goes into the creation of MLPs-take a bunch of assets, separately capitalize them and get a cash infusion and an income stream consisting of over-rides of some sort plus management and performance fees which may be of any level of complexity.

How about the entire enormous market for mortgage debt? This area can be mind-bogglingly complex and pays a very good living to many traders who have the interest and tools to understand and exploit their complexity.

MITTs, currency structured notes, and equity structured notes can be even more abstract and get further from the operation of one company or even any concept of company at all as in the case of currency based products.

All these things are created and let loose into a trading market with a more of less defined cost structure that will be borne by the holders of the securities out of the total cash flow accruing to the security. They should be distinguished from any offering, usually made by an insurance company or mutual fund organization, that must support a marketing organization. So they all require an investor who has the skill and the interest to dig around until he or she knows what is going on

Since people like this don't grow on trees, there will frequently be mis-pricings of various degrees. This isn't theory; it is very easy to see almost any day when different securities with identical claims on the same underlying equity or cash stream are priced differently.

These are not going to appeal to someone who places a high premium on straightforwardness and lack of need for analysis. One might expect then that taking the time to explore them could be fruitful, just like when you were in high school it sometimes paid in unexpected ways when you walked on by the cheerleaders and paid attention to the brainy girl with glasses.

But as in all things one lives and learns. Personally, I'll have to see what lessons I am taught by ISM!

For the most part though, as long as I have come upon some area that was not being promoted by anyone, either the original packagers or some investment guru, and did careful research- various classes of these things have tended to pay off well over time. Often with good current income and less than average volatility.

My typical error has been failure to stay around long enough to milk each cow dry.

Ha

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Re: What is your take on Structured Products
Old 04-15-2007, 05:10 AM   #5
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Re: What is your take on Structured Products

In most case the correct response to somebody trying to sell you one of these instruments is to take out a shotgun, shot the salesman, and the claim you were in acting in self-defense, because your financial health was in serious and immediate danger. If I was on your jury, I'd acquit you.

The question asked is a bit different, because if they are trading in a secondary market, perhaps much of the really bad things about these product disappear because nobody is collecting a commission. I haven't looked (could you give some ticker symbols).

I think the key to understanding any of these product is to seperate all of the pieces and than evaluate them seperately and see if the price is higher than the sum of the individual pieces.

For example a product that guarrantee you the greater of your original investment or 75% of the yearly changes of the S&P 500, up to a maximize of 12%/year can be deconstructed into a three parts.
A 5 years zero coupon with a face value equal to your original investment. (I.e. the guarrantee of your principal)
Purchasing five (one for year) at the money 1 year covered call worth 75% of the investment
Selling/Writing five calls with a strike price 12% higher than the S&P 500

Now the interesting thing to me is that I do remember reading article form well known investment guys (don't remember who.) that is quite likely that the insurance company were selling portfolio insurance too cheap, so maybe these things really are good deal once the commission, and M&A expenses are removed.
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Re: What is your take on Structured Products
Old 04-15-2007, 05:45 AM   #6
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Re: What is your take on Structured Products

Quote:
Originally Posted by clifp
... Now the interesting thing to me is that I do remember reading article form well known investment guys (don't remember who.) that is quite likely that the insurance company were selling portfolio insurance too cheap, so maybe these things really are good deal once the commission, and M&A expenses are removed.
Insurance companies make mistakes sometimes on insurance product design and commission structure. Such that the agent and/or customer is getting a better deal than can be had at other companies. When this happens, the Ins company catches on and closes the product line. It does happen though.

On the structure products... It seems to me that they tend to be offered mainly by Investment Banks. Of course, there may be a insurance company in the mix since large financial groups have an insurance subsidiary or vice versa.

Some of these things are fairly exotic. I believe they can serve a usefule purpose as long as one understands what they are doing. However, it also seems to me that an individual might be able to contruct/clone a similar instrument (the simpler ones) themselves by using certain hedging techniques.

Personally I use plain vanilla tools such as bond and stock mutual funds.... GO LONG! If I ever take on something like a structured product or a surface level derivative, It would be for the hedge benefit rather than a bet to win.

I find the evolution of our financial markets very interesting with all of the new products... But I also know that there is no free lunch. If I am sitting at the poker table and do not know how to play... chances are I am the sucker feeding the pot.
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Re: What is your take on Structured Products
Old 04-15-2007, 06:50 AM   #7
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Re: What is your take on Structured Products

Quote:
Originally Posted by chinaco
I find the evolution of our financial markets very interesting with all of the new products... But I also know that there is no free lunch. If I am sitting at the poker table and do not know how to play... chances are I am the sucker feeding the pot.
Well said! You gave yourself the best advice.
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Re: What is your take on Structured Products
Old 04-15-2007, 07:34 AM   #8
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Re: What is your take on Structured Products

Quote:
Originally Posted by HaHa
it is very easy to see almost any day when different securities with identical claims on the same underlying equity or cash stream are priced differentl
I wonder how true this really is these days (assuming you are looking at prices at which you can actually execute the trade). Unless the size of the trade that could be done is so small that no one cares, I would think these sort of "inefficiencies" would be pretty well arbed away by hedge funds or the trading departments of the investment banks that created these structured products in the first place.
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Re: What is your take on Structured Products
Old 04-15-2007, 08:30 AM   #9
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Re: What is your take on Structured Products

apropos this thread is the lite article on structured products in the sunday WSJ:
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Re: What is your take on Structured Products
Old 04-15-2007, 08:38 AM   #10
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Re: What is your take on Structured Products

(message deleted, after I realized that my post was referencing a different security-type, which was effectively an in-the-money put option disguised as a 'bond')
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Re: What is your take on Structured Products
Old 04-15-2007, 08:43 AM   #11
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Re: What is your take on Structured Products

Quote:
Originally Posted by FIRE'd@51
I wonder how true this really is these days (assuming you are looking at prices at which you can actually execute the trade). Unless the size of the trade that could be done is so small that no one cares, I would think these sort of "inefficiencies" would be pretty well arbed away by hedge funds or the trading departments of the investment banks that created these structured products in the first place.
Think closed end mutual fund. They often trade at premiums and/or discounts. Thinly traded shares (few buyers and fsellers) cause price vs current worth discrepancies in an auction.. Plus, Forward looking projections for the underlying assets sometimes create an imbalance in the current value vs price... since there are multiple assets bundled together that cannot be busted out and sold seperately.
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Re: What is your take on Structured Products
Old 04-15-2007, 08:48 AM   #12
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Re: What is your take on Structured Products

Quote:
Originally Posted by LOL!
apropos this thread is the lite article on structured products in the sunday WSJ:
Good article. Clearly points out that there is "no free lunch" even with no fees - one is paying for the protection by giving up the dividends, and it also emphasizes the European nature of the securities (must hold until maturity to be guaranteed full return of principal).

For someone who wants this type return pattern (and doesn't want to create it himself with zero coupon notes and call options), I would recommend the exchange traded structured products rather than annuities since they have lower fees and no selling penalties.
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Re: What is your take on Structured Products
Old 04-15-2007, 08:56 AM   #13
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Re: What is your take on Structured Products

Quote:
Originally Posted by chinaco
Think closed end mutual fund. They often trade at premiums and/or discounts. Thinly traded shares (few buyers and fsellers) cause price vs current worth discrepancies in an auction.. Plus, Forward looking projections for the underlying assets sometimes create an imbalance in the current value vs price... since there are multiple assets bundled together that cannot be busted out and sold seperately.
Even if you buy a closed-end mutual fund at a discount, there is no guarantee that it will ever trade at NAV again. In fact, the discount can become greater.

I'm not saying there's no value in doing this. If you are a long-term investor looking for higher yields, this probably would be preferable to buying the underlying stocks. All I'm saying is that you should understand the risk you are taking when you do this.
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Re: What is your take on Structured Products
Old 04-15-2007, 09:45 AM   #14
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Re: What is your take on Structured Products

Unless you can buy enough of it, then become an activist investor and convert it to open-end. This seems to be happening a lot lately.
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Re: What is your take on Structured Products
Old 04-15-2007, 09:59 AM   #15
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Re: What is your take on Structured Products

This thread convinces me that there are 2 kinds of people. Those, who on seeing something in the sidewalk that appears to be a $20 bill go pick it up and examine it; and those who say confidently to themselves- "It can't really be a $20 bill, someone already would have picked it up, and anyway the effort of picking it up would surely cancel the value added."

Ha
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Re: What is your take on Structured Products
Old 04-15-2007, 11:24 AM   #16
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Re: What is your take on Structured Products

One product with limited downside that used to be offered was a type of CD tied to an index like the S&P. You signed up for, say, five years, and at the end you either got a percent (typically high, around 80%) of the S&P increase over those five years, or your original money back if the S&P was flat or went down. So you have the upside of the S&P with no downside at a cost of around 20% premium.

I did't invest in these, but I did think about doing the same thing by buying a govt bond and using the interest I would gain to buy a LEAP call option on an index. This is probably what those banks did, but this way it would be totally transparent to me, and I would be completely in control.
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Re: What is your take on Structured Products
Old 04-15-2007, 12:46 PM   #17
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Re: What is your take on Structured Products

Quote:
Originally Posted by FIRE'd@51
Even if you buy a closed-end mutual fund at a discount, there is no guarantee that it will ever trade at NAV again. In fact, the discount can become greater.

I'm not saying there's no value in doing this. If you are a long-term investor looking for higher yields, this probably would be preferable to buying the underlying stocks. All I'm saying is that you should understand the risk you are taking when you do this.
Agreed. I was pointing to the similarity in trading at a discount/premium because of limited buyers and sellers.
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Re: What is your take on Structured Products
Old 04-15-2007, 01:07 PM   #18
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Re: What is your take on Structured Products

I've also read somewhere that some SPs will do even dirtier tricks like taking the geometric mean of the S&P vs the Arithmetic mean to calculate monthly returns, or other math-tricks. Read very carefully.
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Re: What is your take on Structured Products
Old 04-15-2007, 01:29 PM   #19
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Re: What is your take on Structured Products

Quote:
Originally Posted by Olav23
I've also read somewhere that some SPs will do even dirtier tricks like taking the geometric mean of the S&P vs the Arithmetic mean to calculate monthly returns, or other math-tricks. Read very carefully.
: : :

Its not a dirty trick. Read the effing fine print!
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Re: What is your take on Structured Products
Old 04-16-2007, 08:08 AM   #20
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Re: What is your take on Structured Products

The April 14th Scott Burns column discussed equity-indexed annuities.

Mr. Burns gives a link to an academic study with this conclusion:
Quote:
Moreover, after ten years the expected benefit of the Equity Indexed Annuity was only $219 when it did better but the expected benefit from the simple portfolio was $33,650. Researchers McCann and Luo concluded that EIAs cost the investor about $153 for every $1 of possible benefits.
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