Structured funds are investment vehicles that combine equity and fixed-income products to balance capital protection and appreciation. They offer investors a hybrid approach, aiming to provide steady returns while mitigating risk through diversification across asset classes. These funds typically employ various financial derivatives to achieve their investment objectives.
In this blog, we’ll explore what is a structured fund, it's types, examples, how does it work and who should Invest.
What are structured funds?
A structured fund includes equity-linked financial products and fixed-income products to create a portfolio. It provides investors like you to enjoy the benefits of both capital appreciation and capital protection. To make your capital grow, a structured fund may invest in derivative financial products (such as futures and options) that are often linked to market indices.
How do structured funds work?
Structured funds achieve their investment objectives primarily through investment in derivatives, unlike conventional funds that invest directly in stocks, bonds, etc. A typical structured fund enters into an over-the-counter (OTC) index-linked swap with a financial institution, enabling the fund to receive investment returns based on the performance of an underlying index.
There are two main types of structured fund swap structures:
- Funded swap: The fund delivers the net proceeds from subscriptions to the swap counterparty and receives a return if the underlying index performs well. The fund's exposure to the counterparty is collateralised up to at least 90% by a pool of securities.
- Unfunded swap: The fund uses subscription proceeds to purchase a portfolio of securities. It then enters an OTC swap, using the returns from the securities portfolio to exchange for the performance of the underlying index.
Structured funds are usually passively managed, and some may offer payouts if pre-determined conditions are met. However, they expose investors to counterparty risk, as the fund's performance is linked to the creditworthiness of the swap counterparty.
Also read: Different Types of Investments
Examples of structured funds
Below mentioned are examples of Structured Funds:
Example 1
Let us try to understand this concept with an example. Suppose, there is a structured fund based on S&P 500 index. Let us assume it aims to protect 80 per cent of the principal amount. So, the structured fund will invest 80 per cent of the fund in financial products that provide fixed income. This ensures that there is almost no chance for the value of a structured fund to fall below the principal amount.
Example 2
Suppose, you have invested Rs. 10,000 in a structured fund.
- To protect the capital, 80% of the fund is invested in debt securities for 3 years (36 months). It provides you with a yield of 7% p.a. The principal amount invested in debt securities is Rs. 8,000. This gives you an interest income of Rs. 1,680. Your invested money of Rs. 8,000 increased to Rs. 9,680.
- The rest 20% of the fund is invested in Nifty. This means Rs. 2,000 is invested in Nifty
- If Nifty doubles in 3 years, your Rs. 2,000 investment increases to Rs. 4,000 in just 36 month.
- If Nifty falls by 50% in the next 3 years, your Rs. 2,000 investment decreases to Rs. 1,000 in just 36 months. Therefore, your investment of Rs. 2,000 falls to Rs. 1,000.
- Your expected return from the structured fund is:
- Scenario #1: If Nifty doubles in 3 years, your total investment of Rs. 10,000 increases to Rs. 9,680 + Rs. 4,000 = Rs. 13,680.
- Scenario #2: If Nifty falls by 50% in 3 years, your total investment of Rs. 10,000 increases to Rs. 9,680 + Rs. 1,000 = Rs. 10,680.
This is a simplistic structure fund, whose expected return ranges from Rs. 10,680 to Rs. 13,680. It shows that your capital of Rs. 10,000 is protected even when there is an adverse market condition. In favourable market conditions, your investment of Rs. 10,000 will become Rs. 13,680 in 36 months.
To provide you with higher returns, a structured fund can deploy more complex quantitative strategies.
Types of structured funds
Structured finance has been there in the market since the mid-1980s. Some of the most commonly found structured funds include:
- CDOs (Collateralised Debt Obligations)
- CBOs (Collateralised Bond Obligations)
- CMOs (Collateralised Mortgage Obligations)
- Synthetic financial instruments
- Syndicated loans
- Credit default swap
- Collateralised debt obligations
- Mortgage-backed securities (both commercial and residential)
- Asset-backed securities
Also read: What is SWP in mutual fund
How to invest in structured funds
To invest in structured funds, you can follow these steps:
Understand Structured Funds
Structured funds are collective investment schemes that achieve their objectives primarily through investments in derivatives. They offer exposure to specific markets or asset classes while managing risk through various protection mechanisms.
Choose a fund
Select a structured fund that aligns with your investment objectives, risk tolerance, and financial situation. Ensure you understand the fund's structure, investment details, and potential risks.
Open an account
Open an account with a financial institution or a registered intermediary that offers structured funds. This may involve paying an application fee, which can be deducted from your investment.
Invest
Invest in the chosen structured fund by transferring funds to your account. Be aware that structured investments are typically buy-and-hold investments, and early redemption may be subject to fees and penalties.
Monitor and review
Regularly monitor your investment and review the fund's performance to ensure it remains aligned with your goals. Be prepared for potential losses or changes in the fund's terms.
Who should invest in structured funds?
This investment opportunity is best for you if you are looking for an investment opportunity that will:
- Provide you with a conservative investment opportunity to protect your capital from depletion or downward movement
- Help your investment grow during upside price movement in the market
Structured financing and securitisation are most commonly used by:
- Corporations
- Governments
- Financial intermediaries
Also read: Inheritance tax meaning
Benefits of investing in structured funds
More and more investors are investing in structured funds for:
- Managing risk
- Developing financial markets
- Business reach expansion
- Designing new funding instruments to advance and evolve complex emerging markets
By using structured funds, the institutions and corporations:
- Transform cash flow
- Reshape financial portfolios’ liquidity
A part of it is done through the transfer of risk from the structured product sellers to buyers. For removing specific financial assets from their balance sheets, many financial institutions are using structured fund benefits.
Summary
In India, many wealth management companies, private banks, and NBFCs are offering structured funds to their valuable customers. They usually enable their High Net worth Clients (HNIs) to invest in these funds so that they can get good returns from their investment at low risk. Subject to prevailing market conditions, a structured fund usually provides its investors with a 10-25% CAGR (compound annual growth rate) return within a 1-3 year span. As highly efficient fund managers manage them, a structured fund can meet investors’ goals even in adverse market conditions. In India, an HNI can invest in a structured fund if the investment size is at least Rs. 25 lakhs.
If you are a newbie in your investment journey but want to start your investing discipline in small steps, mutual funds are the best option available. An efficient fund manager will pool money from investors with similar risk profiles and invest in different financial assets to help meet their financial goals. If you want to get expert help by investing as low as Rs. 500 or Rs. 1,000, explore the Bajaj Finserv Mutual Fund Platform. You will find 1000+ mutual fund schemes to choose from. Always compare mutual funds before investing.
