Summary
Structured funds are a combination of fixed-income products and derivatives. It helps investors to balance their investment between growth potential and risk management.
It is suitable for investors who want their investment to stay for a long period and earn regular returns and also benefit from the market variations.
What is a structured fund?
A structured fund or product is a specialised investment that combines multiple financial instruments to achieve the investment objective. It invests in both regular fixed-income funds, such as government bonds, and derivative products, such as options and swaps, to maintain diversification of the investment portfolio and balance potential growth with capital protection.
Unlike mutual funds, whose primary focus is investing directly in instruments such as equities, bonds, and other securities, structured funds focus on diversification alongside controlled market exposure through derivatives.
How Do Structured Funds Work?
The structured funds investments are separated into two components. They are mentioned below.
- Fixed-income component: The majority of the investment is invested in a fixed-income financial instrument to ensure capital protection. A substantial portion of the investment is placed in bonds or certificates of deposit to earn stable returns and support capital preservation.
- Derivatives component: The remaining portion of the investment is allocated to derivative instruments, such as options, futures, and swaps, providing investors with the opportunity to earn market-linked returns and benefit from market movements. They invest in call or put options, futures contracts, and swaps. This provides investors with the opportunity to experience the market movements and seek growth opportunities.
The structured funds are for investors who seek long-term funds that provide growth and also facilitate regular income on their investment. To balance risk and return, the fund manager invests the majority of the portfolio in fixed-income securities and a smaller portion in derivatives that can generate returns based on market performance.
Types of Structured Funds
The structured fund can be categorised into various categories based on its investment objectives and risk profiles.
| Type | Explanation |
| Capital-protected structured funds | Aim to preserve part or all of the invested capital while giving market-linked upside. |
| Growth-oriented structured funds | Use derivatives to participate in equity, index or commodity movements. |
| Income-oriented structured funds | Aim to provide periodic income through fixed-income assets and derivative-linked payouts. |
| Barrier-based structured funds | Returns depend on whether the underlying asset crosses a pre-set market level. |
| Buffer or defined-outcome funds | Offer partial downside protection while allowing limited upside participation. |
| Multi-asset structured funds | Combine debt, equity, derivatives or other asset classes to create a specific risk-return profile. |
Advantages and Limitations of Structured Funds
The structured funds have several advantages and disadvantages. Some of them are mentioned below.
Advantages:
- Tailored risk and reward: Structured funds provide a customized investment approach, enabling investors to align risk exposure and return expectations with their financial needs. They can be customized according to their investment objectives and risk appetite.
- Diversification: The structured funds combine multiple instruments to ensure capital protection alongside potential growth. They spread their investments across different financial instruments, encouraging diversification.
- Downside protection: Since structured funds partly invest in fixed-income instruments, the possibility of loss by market movements is reduced. It helps to limit the losses incurred by the underlying instruments.
- Access to sophisticated strategies: The structured funds allow accessibility to niche strategies, such as foreign exchange and commodities, that are not easily available to retail investors.
Disadvantages
- Complexity: It can be challenging for investors to calculate returns and risks accurately because of the combination of traditional bond investments and derivative instruments.
- Credit risk: The structured fund depends mostly on debt financial instruments. This increases the possibility of default or credit risk. Poor performance by the issuing institution can lead to loss of the principal amount of investors.
- Limited liquidity: The structured funds are mostly preferred to be held until maturity. They may even have a lock-in period. Redeeming the investment before maturity or the lock-in period may result in lower returns or penalties.
- Opportunity cost: The investments in mixed-income instruments provide regular fixed returns, limiting the potential for growth. Therefore, if the underlying assets rise exceptionally high, investors may miss out on the overall returns.
- Fees and costs: The structured funds may include a high expense ratio because of the complex combination of fund instruments and derivatives. They may include various charges that will hamper the overall returns generated.
Practical Applications and Real-Life Scenario
Let’s understand structured funds with the help of examples.
Scenario 1:
A new investor wants to invest in the stock market, but due to a lack of knowledge and experience, he feels uncomfortable investing directly. So, he chose structured funds. He invested the majority of his investment in a government bond and the remaining investment in commodities. This helped him maintain a balance between protecting his capital investment and also investing in the market to gain from market volatility.
When the market rises in the commodities market, he gains a portion from the deviation. And when the market declined, the bond returns helped him preserve a portion of his capital.
Scenario 2:
A retired investor wants to invest with the purpose of regular returns. He chose a structured fund investment that combines both regular bonds and derivative instruments.
This helped him earn regular interest income from the bonds and also protect a good amount of capital when there was a market correction. Moreover, when the market was rising, he earned significant profit from the market deviation.
Conclusion
A structured fund is a specialised product that combines fixed-income securities with derivative instruments, allowing investors to earn regular returns alongside generating profits from market movements. They allocate the investments to ensure capital protection and capital appreciation.
However, structured funds may also have some disadvantages, such as high complexity, not being easily redeemable, including credit risk, and high expense ratios. Although the various types of structured funds allow investors to choose their investment strategies according to their objectives and risk appetite. Therefore, a structured fund is a product that involves the allocation of investments in regular securities and in the market to encourage stable income and generate income from market deviations.
FAQs
A structured fund is a special investment product that combines both regular fixed-income instruments and derivatives markets to create a customised risk and return strategy.
It is less suitable for beginners because of its complexity and requires a good understanding of the market and its movements.
The structured funds generate income through fixed-income instruments and income generated through movements in the derivatives market.
Some of the biggest risks involved in a structured fund that affect the investment returns are liquidity risk, complexity, market risk, and credit risk. These risks hamper the overall return on the investment.
Mutual funds are investments that collect money from multiple investors to invest directly into stocks, bonds, and other financial instruments. On the other hand, structured funds invest by combining fixed-income instruments and derivatives to balance the risks and returns.
Structured funds generally do not guarantee returns. Some may offer full or partial capital protection if held till maturity, but this depends on the fund structure and terms. Market-linked gains are not assured.
