Why Invest In Structured Deposits?

It seems that the bad memories of the Lehman Brother Mini Bond Saga has been gradually forgotten and life has moved on. Structured Deposits (SDs) are taking a shot at the low interest rate environment to lure conservative investors into parting with their money for slightly higher returns than Fixed Deposits before rates potentially start creeping up.

However, do you know what you are actually buying into?

Generally, SDs are capital protected and give a small fixed return with a potentially higher return if certain criteria are met. It may sound good but how is this achieved?

To simplify, here is an example.
90% of the capital is used to buy a double A rated bond that gives a return of 3% pa for 5 years.
10% is used to buy an option on STI index hitting 4,000 points within the 5 years and will pay out 1.5 times if it occurs.
Ignoring all other costs for simplicity.

Scenario 1 (Happy):
The bond pays out regularly and matures, STI hits 4,000 and total return is 90% x ( 1 + 3% x 5 ) + 10% x 1.5 = 103.5% + 15% = 118.5%

Scenario 2 (Not so happy):
The bond pays out regularly and matures, STI does not hit 4,000 and total return is 103.5%.
10% in the option is a total lost.

Scenario 3 (Extremely unhappy):
The bond issuer goes bankrupt and is not able to repay the debts. If STI hits 4,000 maybe the investor gets back 15%, if it does not, the investor gets 0%. Either way, the investor is not going to be satisfied.

Why are people still investing in such a product?
In my opinion, the risk - reward is not attractive at all. It is risking a potential lost of 100% for a miniscule return.

For bonds, a unit trust that invest into a diversified portfolio of government bonds and currency hedged with a long performance history would offer a better alternative compared to a single bond purchased by the offering bank with no track record. It would be like purchasing into a black box and being locked in for 5 years as compared to being able to sell off as a whole or in portions any time if necessary. Due to diversification, it would be unthinkable that the whole unit trust portfolio of bonds goes bankrupt at the same time to lose the whole amount of capital. Alternatively, a local government bond ETF might also be better.

For options, if you were to invest on your own, you can choose the triggering event or even spread across multiple events of your own liking.

Ultimately, much of the SD returns goes towards marketing, commissions, transactional, profits, maintenance, servicing, etc.

Anyway, for those who still wish to purchase SDs due to the convenience of letting the bank do everything. Do look out for the following:

Image from SIAS website

1. Understand all the key features of the product. Mainly, what is the worst- case scenario and what is the possibility of it happening. Do differentiate fact from opinion of what the banker tells you, it is your money, not his/hers, you might not be able to hold them responsible for your bad investment decisions.

2. Think about your future cash flow needs and opportunity cost as you must hold the product to maturity else you will most definitely suffer losses for early redemption.

3. Structured deposits are generally not covered by deposit insurance. Furthermore, capital protection is not the same as capital guaranteed, you may lose everything if the carrying bank goes bankrupt.

Lastly, SDs can be very complex instruments, so do not put your money in what you do not understand!