As we explain in our guide to structured products, there are three different categories of investment, as defined by how much protection they claim to offer the investor.
- 100% protection
- Partial protection
- No protection
Let’s explore these three layers of protection in this separate article.
100% principal protection
The investor receives the return on the underlying index (provided it has risen), and if it has not risen they receive 100% return of the capital originally invested.
Partial principal protection
A set return of income level is offered, but capital protection is only provided as long as the underlying index does not fall below a certain level. As an example, the capital protection might apply on so long as the S&P 500 does not fall below 60% of its starting level. This is also known as ‘soft protection’ or ‘contingent protection’ as it is still conditional on an uncertain event.
Some structured products give no capital protection at all. Instead, they offer exposure to 100% of the movement in the underlying index, or perhaps provide an additional (leveraged) return.
Which level of protection is best?
Each type of structured product carries a different level of risk. Therefore your preference may depend on your personal appetite for investment risk.
Also, as we explain in our main article, structured products are a perfect example of the trade-off between risk and reward. Products which provide less protection will be able to offer you a higher return.
This is because each element of protection in a structured product will cost money. The more money an investment manager spends on protection, the less they’ll have left to buy investments to produce your return.
Only you will be able to decide which combination of return and protection is most appealing for your circumstances.
As a reminder, structured products can be far riskier products than they might initially appear. Investing books will recommend depositing no more than 10% of your portfolio into a structured product. I do not recommend them being considered equivalent to an asset class in their own right – due to a lack of diversification, particularly when it comes to counter party risk.