SLCG study finds that structured products underperform stocks, bonds

By Angela McDaniels

Tacoma, Wash., Nov. 5 - Structured products generally underperform simple alternative allocations to stocks and bonds, according to a study done by the Securities Litigation and Consulting Group, Inc.

"Our results strongly suggest that retail investors should avoid structured products. Because of high initial embedded fees, investors have earned ex-post returns that are highly correlated with, but lower than, returns on simple combinations of liquid stocks and bonds," the study authors said.

The study analyzed the ex-post returns of 17,925 individual dollar-denominated structured products issued from January 2007 to April 2013.

The period was divided into six-month holding periods. The study found that for a great majority of the holding periods, a portfolio of stocks or bonds produced higher returns than a portfolio of structured products.

A portfolio of 100% stocks outperformed the structured products in 74.7% of the six-month holding periods, a portfolio of 80% stocks and 20% bonds outperformed in 79.3% of the periods, and a portfolio of 100% bonds outperformed in 54.4% of the periods.

By how much did the stocks and bonds outperform the structured products? The average overperformance for a portfolio of 80% stocks and 20% bonds was 10.5% compared to reverse convertibles, 10.9% compared to single-observation reverse convertibles, 4.2% compared to tracking securities and 24.5% compared to autocallable securities.

Correlation

The study also found that the structured products were highly correlated with changes in the S&P 500 Total Return index and weakly positively correlated with changes in the Barcap Aggregate Bond Total Return index.

The correlation was 96% for the S&P 500 Total Return and 43% for the Barcap Aggregate Bond Total Return.

Sample construction

The study sample included 17,925 structured products registered with the Securities and Exchange Commission that together totaled $33.81 billion.

The sample was limited to reverse convertibles, single-observation reverse convertibles, tracking securities and autocallables.

The authors developed software to automatically search the SEC website for 424B2 forms for structured products issued by 13 issuers: Bank of America Corp., Bank of Montreal, Barclays Bank plc, Citigroup Inc., Credit Suisse AG, Deutsche Bank AG, Goldman Sachs Group Inc., HSBC USA Inc., JPMorgan Chase & Co., Lehman Bros. Holdings Inc., Morgan Stanley, Royal Bank of Canada and UBS AG.

Reverse convertibles made up the majority of the sample. They made up 61.3% of the sample by number of issues and 42.4% by dollar amount.

The majority of the products were issued by Barclays, UBS, RBC and JPMorgan.

Indexes

The paper analyzed the returns of the structured products by constructing an index representing all of the structured products and four subindexes representing reverse convertibles, single observation reverse convertibles, tracking securities and autocallables.

The fair value of each structured product was calculated using market data that included stock price, implied volatility, the issuer's credit default swap rate and market interest rates at the end of each business day.

The weight each structured product contributed to the index was determined by the product's calculated market value on the previous business day. After maturity, the structured products were removed from the calculation of index total return.

The study, "Ex-post Structured Product Returns: Index Methodology and Analysis," was authored by Tim Dulaney, Tim Husson and Mike Yan, senior financial economists with the group; Geng Deng, director of research, and Craig McCann, principal.

Securities Litigation and Consulting Group is a financial economics consulting firm based in Fairfax, Va.

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