Structured products are wending their way into portfolios, with investors recently sucking up half a billion dollars on just three new issues of the vehicles - three of some 67 offerings of structured products launched this year.

Some say that the growing appeal of structured products is due to their exotic features. They are packaged and issued by prospectus, and are considered general debt of an issuer such as Morgan Stanley or Merrill Lynch. Most are traded on the American Stock Exchange, with some paying interest. What they all have in common is a portion of the return being pegged to an equity or an index.

The variety of features includes returns linked to different individual equities or indexes, guarantees or not of principal, and a range of call features. As an example, the above-mentioned trio of recent issues from Morgan Stanley and Merrill Lynch are all pegged to the CBOE S&P 500 BuyWrite Index.

The index measures the total rate of return of a "buy-write" or "covered call" strategy on the S&P 500 Index, based on rolling one-month, at-the-money options on the S&P 500 Index. Each structured product offers a different calculation for return based on the index. The Morgan Strategic Total Return Securities series pay no interest, but are exchangeable for a cash amount on July 30, 2011, tied to the close of the index. Merrill issued strategic return notes, or SRNs, paying 8 percent interest and expiring on June 7, 2010.

Some CPA financial advisors, however, are urging their clients to exercise caution with regard to structured products.

"These are great selling tools," said Benjamin Tobias, CFP, CPA, CIMA, of Tobias Financial Advisors, in Ft. Lauderdale, Fla., "and when a client brings one in for review, I have to really go to work to make sure they don't buy it. Each one works differently. And there's usually a catch like a call feature that can only be found by reading through each prospectus carefully."

The Chicago Board Options Exchange index-linked product may also be less time-consuming to analyze than the more mature product, with a return linked to the value of an individual underlying security.

Take the example of Lehman Brothers' Yield Enhancing Equity Linked Debt Securities, listed on March 1, 2004, and expiring Sept. 3, 2005. Holders receive 7.5 percent interest and, at maturity, an amount of principal plus an alternative redemption amount that is directly related to the performance of the common stock of electricity producer Calpine. The redemption amount can be positive, negative or zero.

"In addition to reading the terms of the deal in the prospectus, I'd have to analyze the issuer, Lehman Bros., and the prospects for Calpine," said James A. Shambo, CPA/PFS, of Lifetime Planning Concepts, in Colorado Springs, Colo. "These products might appeal to firms that are set up to offer individual securities."

The layers of analysis needed for single-stock products might explain one of the strong trends in the industry over the last two years. Growing numbers of new issues use an index base over a single stock. Another distinct trend is the move away from the feature of principal protection. "As investors get more comfortable with the product, the demand for protection seems to be diminishing," says Richard Mikaliunas, senior vice president of capital markets at the American Stock Exchange.

One trend that has not changed much since the first introduction of retail structured products is the dominance of the Amex in numbers of listings. In addition to capturing the listings of most of the exchange-traded funds, Amex boasts the lion's share of structured products. Mikaliunas credited their success to superior service and knowledge of how to get the Securities and Exchange Commission to change the rules to accommodate the new structures.

"Amex has made a name for itself with these listings," said Mikaliunas. "We not only spend time handholding issuers and their law firms, but we have been very successful in knowing how to advise clients on what new forms might be acceptable to the regulators."

Growth in the industry has spawned several changes. There's now a trade association serving both retail and institutional issuers called, appropriately, the Structured Products Association (online at www.structuredproducts.org).

The products' rising popularity has prompted issuers to shift employees to assist with internal marketing. Mikaliunas reported the example of Citigroup, where part of the option staff moved into the structured product marketing area. Industry experts foresee issuers both broadening distribution to third-party networks, and the entry of more issuers into the marketplace. "We expect more offerings from Wachovia Securities," says Mikaliunas. "They just hired away the bulk of the group of professionals from one of the biggest issuers, Morgan Stanley."

One advisor sees a possible application for clients. Jason Thomas, Ph.D, CFA and chief investment officer of Kochis, Fitz, Tracy, Fitzhugh & Gott Inc., in San Francisco, pointed out that some structured products might make sense for clients with an serious fear of loss. "These may make sense for someone with a particular psychological issue," says Thomas. "Typically, these people won't buy an option, but perhaps the kind of downside protection in these products could fit."

Thomas said that his firm could also consider a structured product as a way to get exposure to certain markets. Some of the products are tied to the Nikkei Index, for instance. Mikaliunas reported growing interest in commodity-linked products, like those linked to indexes of gold or silver mining companies. "The issues would still have to be cost-effective and liquid," said Thomas.

Experts caution that each structured products' offering prospectus, however, must be scoured for risk factors as well as features.

"While the whole story is in the prospectus, the 'catch' might not be printed until halfway through," says Tobias. "There's no free lunch, even though some of these things can make it look like there is."

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