I don't dispute that structured notes have variable payouts, but every offering sheet promises a certain yield at maturity, making them appear to be income products that offer a stated yield. The problem is in the semantics. The language used in promoting them can misrepresent what they are.
While there are structured products that include FDIC-backed CDs, it should be noted that the government will only guarantee the principal, not the entire product or the potential market appreciation (I didn't cover these products because I didn't have a problem with them or find them to be egregious). To say that the government completely guarantees any structured product is misleading. It's easy to get confused the way these products are presented.
Disclosures may state somewhere that these products are unsecured loans, but the offering literature is consistently vague on what they really are. In reading prospectuses from leading issuers, I have yet to see a clearly stated line upfront in the material that states "this is an unsecured loan to the issuer." My problem is the way in which this information is disclosed. Much of it is buried in legalese. The issuers can claim they've disclosed the risks and nature of these investments, but I don't think most investors can comprehend exactly what they are buying.
I did not see any clear disclosure of how the options were priced, and many of these products clearly stated that you could lose money. It's impossible to generalize since all of the products are slightly different and there is no "standard form" for a principal-protected structured product. The Lehman principal-protected notes were undeniably not
principal protected, as more than $1 billion was lost by investors. Any product tied into the credit risk of the issuer, by very definition, lacks true principal protection. If the reader can show me any
prospectus that clearly explains options and zero-coupon bond pricing, I'd be happy to review it. And "the terms of the prospectus" are rarely tilted in favor of the investor, so you don't often know for sure what you'll get at maturity.
I agree that there are many uses for structured products other than for income. Yet in case after case in reviewing FINRA arbitration and enforcement cases, it was readily apparent that older, income-oriented investors were targeted in marketing pitches--many of whom had no business buying them. I have consistently suggested that readers employ an RIA, CFP or non-commissioned advisor to see if these products are right for their portfolios. They can offer diversification, but their high costs and limitations need to be spelled out by someone who understands them.
I agree, you need to shop around, which is why I recommended a third party review them for suitability. Taking the commission out of the equation--and finding a fiduciary advisor--is an important first step to see if these products make sense.
Liquidity is important if you need access to your funds. And yes, lock-in periods vary, but should be examined carefully.
Limiting your upside and downside is crucial, and I don't deny that structured products do this. But my point was that there are other products (ETFs, options) that can do this more efficiently and at lower cost (commission-free).
. I don't think there's a disagreement here. My quibble is the way the final value is calculated. In most cases, it's extremely complicated and requires some sophisticated computer modeling. It's not transparent.
Yes, there are plenty of betting strategies available through structured products. If investors want to make sophisticated wagers at a high price, SPs have a lot of appeal. I'd just like to see a full accounting on which of these bets actually reward investors on a net-net basis. Issuers make them so difficult to track, not even Morningstar can follow them.
. Is a structured product "faster, cheaper, easier and safer than doing it yourself?" I beg to differ. When you add in all of the costs, probably not, since you can buy options through a discount broker and get exactly the kind of hedging/speculation strategy you want. Thousands of advisors know how to do this; the key is finding one who is a fiduciary and has the right experience and training, which most brokers don't have.
One final note (and this is crucial for Morningstar readers): The Wall Street Journal
last week reported that the SEC and FINRA are both probing structured products (reverse convertibles), which I have reported on
State regulators (www.nasaa.org
) have also formed a task force to investigate structured products, so the myriad concerns about these products are fairly widespread in the regulatory community. You can also check www.finra.org
to see which firms have been fined for selling these products and the multiple warnings the security agency has issued since 2005.
In my humble opinion, structured product sales abuses will continue until all brokers are required to be fiduciaries, that is, take legally responsibility for their client's best interests. Unfortunately, the securities industry is vigorously fighting the SEC's implementation of that recommendation.
--John F. Wasik
John F. Wasik is a Morningstar columnist and author of 13 books, including The Cul-de-Sac Syndrome: Turning Around the Unsustainable American Dream. The views expressed in this letter do not necessarily reflect the views of Morningstar.com