IN recent times, significant levels of volatility have returned to asset prices due to uncertainty with key variables such as the direction of US interest rates. This creates the perfect environment for the creation of structured products and may be worthwhile to consider for your portfolio.

Structured products are investments that afford potential investors the opportunity to earn higher returns than those otherwise offered by traditional deposit products or bonds, as well as the chance to achieve increased portfolio diversification. Structured investments are usually designed to produce returns that are dependent on the performance of particular underlying benchmarks such as interest rates, equity markets, commodities, corporate credits or foreign exchange markets.

A structured investment can therefore be an equity-linked note, interest rate-linked note, currency-linked note or deposit, credit-linked note or commodity-linked note.

For example, a five-year note based on the performance of the US LIBOR rate (London interbank offer rate) may offer a coupon rate of 10 per cent per annum payable on a quarterly basis each day that LIBOR is within the range of zero per cent to five per cent. However, the note will not accrue any interest for any day LIBOR falls outside the range, for instance when the rate is above five per cent.

Another example is an equity-linked note tied to the performance of the S&P 500 index where the note offers to pay a coupon rate of 15 per cent per annum each day the S&P 500 stays within the range of say, 1,500 and 2,500, but zero per cent on any day the index falls below 1,500 or is above 2,500.

Additionally, an investor who is indifferent between two currencies (the euro and US dollar, for example) and has a particular view on the potential movement of the exchange rate, may be interested in a dual currency deposit linked to the performance of the two currencies. If the EUR/USD exchange rate stays within the range of 1.12 and 1.15 over a 2-week period, for instance, the deposit may offer a coupon rate of say, 20 per cent p.a. each day of the two-week period that the exchange is within the specified range — but nothing if the range is breached.

Structured products can be an attractive addition to your portfolio, as they give you the flexibility to tailor an investment structure to meet your specific financial objectives — taking into consideration such factors as your goals, risk tolerance and time horizon. You are also able to incorporate non-standard features into these investments, including principal protection, exposure to less accessible markets and/or indices, options and swaps. Some of these additional features, however, may carry extra risks or charges.

Risks involved in structured products include the following:

* Credit risk — structured products are unsecured debts usually issued by international investment banks and therefore the prospects for principal repayment is contingent on the credit worthiness of the issuing investment bank.

* Lack of liquidity — structured products rarely trade after issuance and anyone looking to sell a structured product before maturity should expect to sell it at a significant discount. They are therefore usually “buy and hold until maturity” investments.

* There is no uniform standard for pricing, and structured products are usually valued using matrix pricing which is essentially a best-guess approach.

* Principal investment may be guaranteed but returns are not. Returns are based on the performance of the underlying instrument within the particular structure.

Alas, structured products are not suitable for everyone and are usually reserved for high net worth individuals and institutional clients due to their complexities, deal sizes and inherent risks.

Before making a decision to invest in a structured product, be sure to discuss this with your investment banking advisor or financial planner. They will review your personal circumstances, risk tolerance, financial needs and objectives in order to determine whether a structured product would best meet your needs.

As structured products tend to be quite complex, it is important for you to understand the product you are investing in, especially its risks.

Eugene Stanley is vice president — fixed income and foreign exchange trading at Sterling Asset Management. Sterling provides medium to long-term financial advice and investments in U.S. and other world market currencies to the corporate, individual and institutional investor. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm. You may visit us on Facebook or follow us on Twitter and for more information please visit our website www.sterling.com.jm