Risks of Structured Investing

Whilst there are many benefits of structured solutions, there are also risks associated with purchasing them that often mirror those of other investments. Below is a table showing some of the risks that might be associated with a structured investment and some potential mitigating factors.

Investors who are not sure whether a structured investment is suitable for them should speak to a professional adviser. If they do not want to take any risk to their capital or income, they may wish to consider whether structured investments are appropriate for them.

Risk

 

Description

 

Potential Mitigating Factors

Market risk That the return from the investment is zero or even negative due to adverse market conditions Seek investment advice on future market trends and ensure the payoff reflects that view
Credit risk The asset itself goes bankrupt, for example, the issuer of a bond within a portfolio does not repay the principal or interest Assess the credit worthiness of the assets the solution is linked to
Counterparty risk The issuer of the investment does not repay the principal or return Assess the credit rating of the issuer and other relevant information such as the credit spread and strength of the balance sheet
Tax risk The treatment of the investment from a tax perspective changes due to new regulations or legislation Seek advice from tax and legal professionals
Inflation risk The return from the investment does not exceed the inflation rate Consider investments linked to the inflation rate or with a minimum return similar to the inflation rate. Alternatively, look at assets that may outperform inflation
Liquidity risk There is only one market maker for the investment who does not make an after sale market or quotes a wide bid-offer spread Invest only in investments where the issuer commits to making an after sale market in a place that you or your adviser can see the prices e.g. the Internet, Bloomberg or Reuters. Ensure the spread indicated under normal market conditions is reasonable for the related asset
Term risk That the money invested is needed before it is due to mature Invest for periods that match future cash flow needs and look for a liquid after sale market
Dividend risk That the return from the investment underperforms the related asset including any dividends paid Consider solutions that pay a total return including dividends from the related asset. Alternatively, look at investments that pay a higher income than the dividend yield for the asset with a similar level of risk. This type of solution may require some potential upside to be given up
 Income risk That the investment does not pay any income to meet cash flow needs Look at solutions that pay an income  and determine whether it should be variable or fixed.

 

Investors should read the terms and conditions of a structured investment carefully to ensure they are comfortable that they are consistent with their investment views, objectives and attitudes to risk. If there is any doubt, there is merit in seeking independent investment, legal and tax advice.

There are additional risks for organisations selling structured investments including, but not exclusively, settlement risk, reputation risk, selling risk and operational risk depending on whether they are booking trades on balance sheet.

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