There is a common myth among novice investors that financial companies add so-called “dark horses” to their structured products along with high-quality securities. And supposedly the task of such assets is to leave the investor without income and part of the investment. Is it really so? We will tell you in this article.

What is a structured product

This is a ready-made investment solution with predetermined conditions – term, risk, composition. A structured product is a combination of traditional financial solutions (bonds, currency) and derivative financial instruments (futures, options). The former work to protect capital, while the latter are aimed at generating returns.

At the heart of each structured product there are underlying assets, on the dynamics of which the result of investment depends. And the myth claims that among them there is necessarily a “dark horse”. For example, if a product bets on 5 stocks, 4 of them are of high quality, and one has dubious prospects. But this is not really the case – let’s understand why.

All elements of structured products work towards the same goal. If you think of a structured product as a single mechanism, you can compare it to a car engine.

If you want to add power to the engine, it will not be enough to simply supply more fuel to one of, say, 5 cylinders. The engine simply won’t run properly. Like any balanced mechanism, a structural product requires all of its elements to work in harmony. These elements typically include asset volatility and correlation.
Volatility
is how much an asset changes in price relative to its average value. In other words, if you see a large variation in prices on a chart, that asset is called volatile. Stocks are most often volatile, while bonds, on the other hand, behave more predictably. Structured products with high rates and higher risk usually consist of volatile stocks.
Correlation
shows how the assets within a product interact with each other. If the underlying assets are from the same sector of the economy (e.g. banking or IT), it is likely that their value changes in a similar way. This behavior of the assets increases the probability of a return, but lowers the rate. Conversely, if a product includes assets from different sectors and markets, their dynamics may differ significantly. In this case, it is important that all assets remain within the yield corridor, i.e. do not fall below a certain level.

From this we can conclude that structured products are complex solutions, the work of which depends on many elements. And the investment results are influenced not by one asset, but by all components.
“Failure” of a product is disadvantageous to its seller

The myth about “dark horses” has no basis also because the presence of low-quality assets in products is disadvantageous for the companies that produce them. The best scenario for them is autocall – the early termination of a product. An autocall occurs if, on the reporting date, all the underlying assets are above a certain level – usually above the initial prices. In this case, the client receives coupon income and the full amount invested and often considers buying a new product from the same company, which earns commission as a result.

In addition, a satisfied client may recommend the product that has met expectations to acquaintances, which will also help the company earn money.

If the assets do not grow and the product does not work, the client will not receive income, will remain dissatisfied and is unlikely to use the company’s services again. That is why the presence of knowingly low-quality assets in products goes against the goals of their creators.