Structured Investment Products: Buyer Beware

Born out of the financial engineering of Wall Street, structured products are a buzzword in the investment world. Structured investment products are customized financial investments whose repayment value is tied to certain underlying assets. Those assets can include derivatives, a single security, pools of securities, stocks, bonds, debt issuances, foreign currencies and/or interest-rate swaps.

The Wall Street firms that market and sell structured investments often contend that the products give investors some degree of insulation from market losses. In reality, the sheer complexity of structured investments, along with a lack of transparency and regulatory oversight, negates those claims. Many investors have learned this lesson the hard way. Case in point: Lehman Brothers Principal Protected Notes.

In theory, a principal-protected note is supposed to guarantee an investor’s initial principal investment at maturity, plus a share of any gains that might occur based on what the structured investment is linked to.  The key words, however, are “might occur.”  If a structured product is tied to a stock that plummets in value or to a company that goes bankrupt, investors could see their entire investment wiped out.

That’s what happened with Lehman’s Principal Protected Notes. The so-called principal protection was actually dependent on the company’s fiscal health. When Lehman filed for bankruptcy on Sept. 15, 2008, the firm subsequently defaulted on many of those notes. As a result, investors lost all or a substantial part of their investment.

Many individuals who put their money and faith in structured products were retirees, living on a fixed income. Their sole reason for buying principal-protected structured investments was because their broker represented the products as a low-risk, conservative investment designed, at minimum, to give back their original investment at maturity.

Instead, investors are learning that “principal protected” should more accurately read “buyer beware.”