Brokerages are marketing structured products that use complex derivatives and promising equity-like returns with less risk. But they are not as safe as they may appear to be, and experts say that most of them are actually worth less than what you pay for them, according to Jane J. Kim and Ben Levinsohn in their Wall Street Journal article, “Structured Notes: Not as Safe as They Seem.”
Sales of structured products are at a record high $45 billion so far this year, according to the article, citing StructuredRetailProducts.com. Many brokers and financial advisers are recommending them as a “defensive” way to wade back into stocks and reduce exposure to bond funds, which stand to take a hit when interest rates rise.
With interest rates low and volatility high, fewer firms are willing to sell 100% “principle protected” products cheaply enough to lure buyers. That is why most structured products that are currently being sold offer only “buffered” or contingent protection.
As an example, the article describes a product marketed by UBS called Return Optimization Securities with Contingent Protection. Investors get 100% principal protection as long as the Standard & Poor’s 500-stock index hasn’t fallen more than 30% at the end of the product’s three-year term. But if the index falls more than 30%, the investor bears the entire loss. If the index rises, the investor receives 1.5 times the gain, up to a cap of 58.6%. Fees, also called the “underwriting discount,” are 2.5%.
Looking at data from 1926 to present, Ibbotson found that the S&P 500 would have declined more than 30% 7% of the time, leaving a hypothetical Return Optimization Securities / S&P500 investor with the entire loss.
Variable annuities with structured products in the underlying sub-accounts are also being marketed. AXA Equitable is selling a group of such products called Structured Capital Strategies. Investors pick a benchmark (the S&P 500, Russell 2000, MSCI EAFE, gold or oil), a time frame (one, three or five years) and some amount of downside protection (10%, 20% or 30%). Their upside (and downside) is determined by their choices.
Many observers believe that these complicated products are a bad deal. Even Ibbotson data in the article suggests that they are a bad deal. Considering a one-year note with protection against up to a 10% drop in the S&P 500, and a 12% cap on participation in S&P500 gains, investors would have been capped out more than 40% of the time since 1926, while benefiting from the downside protection just 14% of the time. The downside protection limit would have been exceeded 19% of the time, resulting in losses.
“You can’t entirely eliminate market risk without also eliminating reward,” Jamie Shepherdson, president of retirement savings at AXA Equitable, was quoted as saying.
The vast majority of these structured products are worth substantially less than the notes’ face value, they can be difficult to sell during a market rout, and they carry counterparty risk, according to the article, citing Craig McCann of Securities Litigation & Consulting Group Inc. SLCG’s web offers analysis and valuations of structured products.
Counterparty risk is illustrated by the so-called 100% principal protected predicts issued by Lehman Brothers and sold by UBS Financial Services, Inc. When Lehman went bankrupt, investors were left with no principal protection at all.
UBS, which reportedly sold $1 billion of Lehman structured products to U.S. investors, is facing many arbitration claims across the country, and has reportedly not yet won a single such case in which the investor was represented by an attorney.
“We continue to receive inquiries from investors who acquired structured notes as a result of misrepresentations that they were ‘principal protected’ investments,” said J. Boyd Page, a senior partner at Page Perry in Atlanta. “Our legal team continues to investigate and pursue arbitrations on behalf of investors who purchased these products,” he added. The brokers who sold the structured notes are not targets of investor claims.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing institutional and individual investors in structured notes litigation and arbitration all over the country. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 40 occasions.