Complete Guide to Structured Products: Risks and Benefits

Are you looking for an investment solution that sits between the safety of euro funds and the potential performance of stocks? Have you heard about structured products, also called "formula funds," but find their operation complex? How can you know if these investments really suit your profile and your objectives?

These financial instruments, designed by banks, promise attractive returns while offering some capital protection. But what really lies behind these formulas? It is essential to decode their mechanics, understand their advantages, and above all, never underestimate their risks. This guide is here to enlighten you, step by step.

What is a structured product?

A structured product, or formula fund, is a financial instrument issued by a bank or an insurance company. It is not a simple product like a stock or a classic bond, but rather a combination of several financial building blocks. Its objective is to propose a customized risk/return profile that does not exist on traditional markets.

To understand its nature, imagine a financial recipe. It generally contains three main ingredients:

1. A bond component: This is the product's safety base. It is most often a bond (a debt security) which, at maturity, aims to repay the initially invested capital, partially or entirely. This is the ingredient that provides "protection".
2. A performance engine: This is the "risky" part that will generate the return. It is made up of derivatives, such as options. These complex financial tools allow betting on the future evolution of a market indicator.
3. A reference asset (the "underlying"): This is the indicator on which everything depends. The performance of the structured product will directly depend on the evolution of this underlying. It can be a stock index (CAC 40, Euro Stoxx 50), a basket of stocks, a currency, or even the spread between two interest rates.

In summary, a structured product is a package that combines the prudence of a bond with the dynamism of an option, all indexed to the performance of an underlying asset. Each product is unique, with its own rules set in advance in a contract.

How do these complex investments work?

The main feature of formula funds lies in their operation: the possible scenarios of evolution are known at subscription. You know in advance what you can earn, what you risk losing, and under which conditions. For that, each product is defined by several key parameters.

• The underlying: The index or reference stock serving as a barometer.
• The maximum lifespan (maturity): The product’s expiration date, generally between 2 and 10 years.
• The target return (coupon): The potential gain, expressed as an annual percentage, that the product aims to distribute.
• The capital protection barrier: The threshold of the underlying’s decline not to be exceeded at maturity for your capital to be repaid. For example, a barrier at -40% means your capital is protected as long as the reference index does not lose more than 40% at the final observation date.
• The observation dates: Periodic meetings (annual, semi-annual...) where the level of the underlying is monitored to determine if coupon payments or early redemption conditions are met.

These investments are designed to adapt to different market contexts, especially in volatile periods, offering return prospects even in stagnation or moderate market decline.

The "Autocall" mechanism: early redemption

The vast majority of structured products offered to retail investors today are "Autocall" (from the English automatic call, or "automatic recall"). This mechanism offers the possibility of redemption before the scheduled maturity date.

The principle is simple: at each observation date (for example, each year), the current level of the underlying is compared to its initial level (the "strike").

• If the underlying is stable or rising: The product is automatically called. The investor then recovers 100% of the initial capital, plus the coupon scheduled for the current year (and sometimes coupons from previous years if they were not paid, thanks to a "memory effect"). The investment ends.

If this condition is never met during the product’s life, everything is decided at the final maturity date. At this time, three scenarios unfold:

1. Favorable scenario: The index is stable or up compared to its initial level. You recover your capital plus the last coupon and all those held in memory.
2. Medium scenario: The index has fallen but without crossing the protection barrier. For example, it has lost 30% while the barrier was set at -50%. In this case, you recover only your initial capital. You have neither earned nor lost.
3. Unfavorable scenario: The index has dropped and crossed the protection barrier. For example, it has lost 60%. You then suffer a capital loss equivalent to the total drop of the index since its initial level. Your loss is therefore 60%.

The importance of the protection barrier

The protection barrier is the true safeguard of your investment. The lower it is (for example, -50% or -60%), the stronger the protection because it would require a very significant market drop for your capital to be at risk at maturity. This barrier may apply to coupon payment (a coupon barrier) and/or capital protection at maturity (capital protection barrier).

The different types of structured products

These products can be classified into four major families, from least risky to most aggressive.

Guaranteed capital products vs. protected capital products

This is the most fundamental distinction.

• Guaranteed capital products: As their name indicates, the issuing bank commits to repay 100% of your capital at maturity, regardless of the performance of the underlying. This is the pinnacle of safety in this universe. In exchange for this total guarantee (excluding issuer default), the potential return (coupon) is generally lower.
• Protected capital products: Here, only part of the capital is guaranteed at maturity (for example, 90%), or the guarantee is conditioned on respect of the famous protection barrier. The vast majority of "Autocall" products fall into this category. The potential return is higher, but the risk of capital loss is real if the unfavorable scenario occurs.

Participation and leveraged products

These two categories are more aggressive and aimed at informed investors.

• Participation products: They allow replication of the underlying’s performance without owning it directly. The interest is often to participate in the rise of an index, sometimes with partial protection against downside.
• Leveraged products: They aim to amplify the changes of the underlying, both upward and downward. They enable exposure greater than the capital invested (for example, a 1% variation in the index results in a 2% variation in the product’s value). The gain potential is multiplied but so is the risk of loss. Turbos and warrants belong to this family.

Advantages and disadvantages: should you invest?

Like any investment, formula funds have a mixed record that must be analyzed clearly before making a decision.

Advantages:

• Known scenarios in advance: This is their main asset. The investment framework (target return, protection, duration) is contractually defined. No surprises on the rules.
• Attractive return potential: They aim for returns often higher than risk-free investments, even in stagnant or slightly declining markets.
• Capital protection: The protection barrier provides a safety cushion that can reassure against stock market volatility.
• Diversification: They allow exposure to a wide variety of underlyings (indices, stocks, specific sectors) and strategies, offering diversification in a portfolio.

Disadvantages and limitations:

• Complexity: Their calculation mechanisms can be hard to grasp for an uninformed investor, despite simplification efforts.
• Risk of capital loss: Except for 100% guaranteed capital products, this risk is real and can be total if the underlying collapses beyond the protection barrier.
• Issuer default risk: Capital guarantee and coupon payments depend on the financial strength of the issuing bank. In case of its bankruptcy, the investor can lose everything even if the product’s formula was favorable.
• Capped return: As explained, you forgo part of the market upside potential.
• Uncertain investment duration: With an "Autocall" product, you know the maximum duration, but not if your money will be immobilized for 1, 5, or 10 years.
• Significant fees: Subscription fees, management fees, and sometimes early exit fees can reduce the final performance.

The risks you must never ignore

Adopting a pedagogical and reassuring approach means being transparent about risks. For structured products, there are many that must be fully understood.

• Capital loss risk at maturity: This is the main risk. If the underlying falls below the protection barrier at the final observation date, the loss is often equal to the full decline of the index. Protection is not absolute.
• Issuer default or bankruptcy risk: A structured product is a debt security you hold on a bank. If that bank fails, your investment is not covered by deposit guarantees. This credit risk is fundamental. You must therefore favor first-rank issuers.
• Liquidity risk: Although it is technically possible to sell a structured product before maturity, this operation can be complex and costly. The resale price is set by the issuer under market conditions that can be very unfavorable and cause a significant loss, much greater than that foreseen by the formula. You should therefore consider this investment as "locked" until redemption (early or at term).
• Disappointing performance risk: A study by the French Financial Markets Authority (AMF) showed that, over the long term, a significant portion of these products may underperform a simple investment in a fund replicating their underlying index, especially when including reinvested dividends.

Who are structured products for?

These products are not for everyone. Because of their complexity, they are intended for investors who already have some knowledge of financial markets and who are able to:

• Understand the formula’s operation and its limits.
• Accept a risk of capital loss.
• Define an investment horizon compatible with the product’s lifespan.
• Bear the immobilization of their savings over several years.

The AMF and ACPR (the regulator of banks and insurance companies) emphasize that nearly half of the structured products marketed in France target "informed" investors. This does not mean they are inaccessible, but that an informational and understanding approach is essential.

At Homaio, we are convinced that financial innovation should not mean opaque complexity. It is possible to offer performing and innovative investments while maintaining complete transparency. This is our philosophy with investment in carbon quotas or emission allowances: a regulated asset, with a clear mechanism and a direct impact on decarbonization. We believe each investor must precisely understand where their money goes and how its performance is generated.

The structured products market in numbers

To better grasp the phenomenon, some data from an analysis by the AMF-ACPR joint unit are enlightening. The French market is very dynamic, with gross inflows rising from 23 billion euros in 2021 to nearly 42 billion in 2023. Life insurance remains the main distribution channel (about 80% of volumes).

Over the 2021-2023 period, marked by generally bullish markets, performances were delivered: the median annual return stood between 6 and 7%, and less than 1% of repaid products recorded capital loss. However, financial authorities remind that these past performances do not predict future performance. A bearish or highly volatile market context could significantly increase loss risk.

Structured products are sophisticated financial tools. They can find their place in a diversified portfolio for informed investors seeking a specific risk/return profile. However, their complexity and risks (capital loss, issuer default, illiquidity) require utmost caution. The key is full understanding before committing. Investment must never equal misunderstanding.

FAQ: Your questions about structured products

How to practically invest in a structured product?

These products are most often accessible as unit-linked funds within life insurance contracts or Retirement Savings Plans (PER). They can also be subscribed through securities accounts. Be aware, their sales periods are often very short (only a few weeks).

What is the taxation of structured products?

The taxation depends on the fiscal wrapper in which the product is held.

• In life insurance or PER: You benefit from the tax advantages of these envelopes, notably after 8 years for life insurance.
• In a securities account: Gains are subject to the 30% flat tax (12.8% income tax + 17.2% social contributions).
• In a PEA (Equity Savings Plan): If eligible, gains are exempt from income tax after 5 years of holding (excluding social contributions).

What fees are associated with structured products?

Fees can significantly impact net returns. They include:

• Entry fees: Sometimes charged at subscription (1% to 3%).
• Annual management fees: Built into the product structure, thus generally "pain-free" for the investor because the stated return is usually net of these fees. They can reach up to 2% per year.
• Envelope fees: Additional management fees for the life insurance or PER contract.
• Early exit fees: In case of redemption before maturity, substantial penalties may apply.

Can I sell a structured product before its maturity?

Yes, in theory, the subscriber can request redemption at any time. However, in practice, it is strongly discouraged. The redemption value is determined by the issuer according to market conditions at the moment and not based on the product’s formula. This value can be much lower than the invested capital, causing an immediate and unpredictable loss. It is therefore wiser to consider this money as unavailable until automatic or final maturity redemption.