Last Updated on 19, April 2018
Many people like to buy structured product. Although this product is currently not popular anymore due to its poor publicity, but it will become very popular again because people has very poor memory. Some of these structured product is really lousy. To understand why, you will need to use probability maths to figure it out.
Product A is linked with the performance of 6 companies. Product A’s performance is linked to the lowest return of the 6 companies. This is what we called a first-to-default product as well. Let’s assume that the probability of a company collapsing is 2%. Than Product A probability of having total lost is 2% x 6 = 12%! This product actually increases the likely hood of failure by the number of companies it has. Mathematically, P(A or B or C or D or E or F) = P(A) + P(B) + P(C) + P(D) + P(E) + P(F). Product A is a lemon but it is highly popular. Why?
Product B is linked with the performance of 15 companies. Product B earns a fix 4% yield for each year provided the 15 companies’ shares are above the original share price. In other words, all 15 companies have to be above “water”. Assuming the probability of each company share price above its original price is 90% (I deliberately give it an optimistic figure. This is reasonable during a bull run). Than the probability of Product B earning 4% for that year is 0.90^15 = 20%! Therefore, even if the market is in a bull run, the chances of the product yield a mere 4% for that yield has been reduced from 90% to just 20%. What is the expected yield? Expected yield is 4%*20% + 0%*80%=0.8%. It will be better of that the investor just buy the 15 companies directly. Mathematically, P(A and B and C….) = P(A)P(B)P(C)….Product B is a lemon but it is highly popular. Why?
Product C is linked with the relative prices of two securities (= Price A/Price B). If Price A > Price B after some period, Product C gives 1% return and give back the capital as well. If Price A < Price B, the investors will suffer the full loses (maximum 100% losses) of the relative Price A/Price B. What is this product? It is called the Dual Currency. Ask those who played this for NZDSGD or AUDSGD pair. I believe their recent return is a double digit lost. It will be better off investing in an ETF than this rubbish. At least in a carefully chosen ETF, there will be upside when the market rebound. For dual currency pair, even if there is a “rebound”, the upside is capped. Product C is a lemon but it is highly popular. Why?
Many structured product is created to be a disadvantaged to the investor. This is done by playing with the game of probability. On a long run, the product manufacturer will win. This is the same as a casino. On a long run basis, they will know that the house will win. Why is it that people like to buy structured product? Some claim they have been misled. However, when times were good I had always advised my clients and others do not tap into those products they wanted to buy. They did not listen to me. Why? It was because of greed and ignorance. There is nothing I can do for “greed” but I could supply the necessary information to fix ignorance problem. However, some of these investors still proceed to purchase them even though I supplied them with the information and arguments. Thus, ignorance is not the reason they bought. Once they are informed, greed is no longer the reason also because a greedy person will not be attracted to returns that are lousy.
The real reason was because the RM who sold the product has a gift of a gap. Secondly the RM represented popular branded institutions (of which many cannot even help themselves these days).
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