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In my last post, I mentioned broker offerings and -- surprise, surprise -- I just ended up getting one from my Muriel Siebert account. The general description of the product is Market Linked Auto-Callable Step-Up Notes Based on the Performance of the EURO STOXX 50® Index. The final maturity date is 20 years from the end of February 2013 and the five-year interest steps are 7.00%, 8.00%, 10.00% and 15.00%. With the Euro stock 50 level at the time of issue as a start point, in order to receive regular monthly payments, the current value of the Euro Stock 50 index must be 80% or more of the start point. When below 80%, no monthly payment. These Notes are callable every five years if the current value of the index exceeds the start point.

The investor is guaranteed to get their principle back, but how many interest payments will be collected can't be predicted. Presumably, Morgan Stanley is betting that Europe is headed down in a big way.

So, does anyone here have experience with structured investments like this?
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Yes.
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So, does anyone here have experience with structured investments like this?

Yes.
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So, does anyone here have experience with structured investments like this?

Yes.

Care to elaborate? Are these products generally a sucker's bet?
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So, does anyone here have experience with structured investments like this?

Ah, Yes. Structured Products. The Sucker's Bet of all Sucker's Bets.

folgore,

Let me offer you a bit of advice. If you can't evaluate a security with your own, already-acquired experience and skills, and if you have to ask about it in a public forum, then you've got no business even considering it.

Ask yourself this basic question: Who is your counter-party to this trade? Do you really, really think you know the game --and its outcome-- better than them that created it? Yes, just often enough to attract a new stream of dumb money, buying "structured products" will pay off. But the game as a whole is a negative-sum game for buyers in the exact same way that roulette is a negative-sum game for players (but not for the house, obviously). Again, ask yourself this basic question. Who is my counter-party to this trade, and what evidence do I have that he is wrong about its direction? Unless you have clear evidence (1) that the originator of the product has made a mistake and (2) that you will be able to exploit that mistake to your advantage, you just gambling in the worst sense of that term. You're the patsie at the poker table. "Welcome aboard. We're glad you could be here."

Structured products are NOT investments by any stretch of the imagination. For sure, they are structured to look like investments, and they are investments for them that create them. They are a sure means of making money for them that create them, and for them that sell them. But for them that buy them, their expected payoff (winners versus losers) across a basket of purchases is about one out of three. Why do I know that? Because I gained that information in the expensive way, by buying structured products and losing. Yes, for sure. On some of them, I made money. On the rest, I lost, just as my counter-party intended.

If you really, really want to gamble, then find a game --like basic, classic, stock investing-- that you have a decent chance of winning, on average and over the long haul.

Charlie
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folgore,

Below is a re-post of a post I did on the topic 08/20/10. Obviously, my opinions on 'structured products' are merely opinions, not exhaustive studies, and they needed to be vetted. But why not save yourself a bunch of highly probably grief and go gamble where the payoffs are much, much bigger and where the downsides are fewer and far more easily understood?

And if you want a clear, simple example of where you could have been looking --since this is a bond board-- why weren't you buying a chunk of Travelport's debt when it was trading low 30's as recently as less than a year ago? The bid is now high 60's, meaning, you could exit --right now-- with at least double on your money in less than 12 months time. No 'structured product' is going to offer you that kind of payoff. However, every one of them is at least as risky. What about adverse, asymmetrical bets (that favor the *seller*, not the buyer) do you not understand?

Stop screwing around looking for pennies on the dollar. Step back from markets and THINK. "Where's the big money trades? Where's the easy money trades?" They are out there by the thousands. All it takes to find a couple of them is a bit of thinking. I watched an interview this morning in which a very ordinary retail investor turned $100k into $41 million in less than ten years.

How? Courage. Persistence. *And* Imagination.


------------------------------------------------

Does anyone on the board invest in structured notes, like reverse convertibles or accelerated return notes, etc?

Zekefaux,

I've bought some reverse-converts in the past. Rather, I should say I was sold some reverse-concerts in the past. But that was long ago when I was still using a "full-service" broker and letting him guide some of my buying decisions.

Joe would call me up to chat and mention that his company was bring to market a reverse-convert based on the price movement of Apple's stock, for instance, with such-and-such upside features and such-and-such downside protection. On that one, I did make good money, but not as much as if I would have bought the underlying directly, and therein lies the problem with all such structured products. The whiz kids who dream up these things are creating products whose average net-expectancy is negative. In other words, "heads we win, tails you lose". In the case of the Apple reverse convert, when the issuer saw that it was going to have to pay out money, it exercised its call option. Had Apple's stock tanked, I would have been the one taking the hit.

I won't say I wouldn't ever buy another structured product, but it is highly doubtful, because the effort to do proper due-diligence is better spent identifying less complex and less adverse opportunities.
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folgore,
My first thought when I read your original post was "Who is the counterparty?"

My next thought was: Since this is a structured product, the counterparty is probably the broker who is trying to sell it. And clearly they are not bringing out a product with the goal of losing money, so they must be planning on *making* money. So they must be planning for their counterparty (that is: me, the buyer) to lose.

No thanks.
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Wikipedia has a good article on ‘structured products’. http://en.wikipedia.org/wiki/Structured_product Here’s a snippet of the important part.

Disadvantages of structured products may include:
• credit risk - structured products are unsecured debt from investment banks
• 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
• no daily pricing - structured products are priced on a matrix, not net-asset-value. Matrix pricing is essentially a best-guess approach
• highly complex - the complexity of the return calculations means few truly understand how the structured product will perform relative to simply owning the underlying asset


Hey, cut me a slice of that. (NOT!)
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Just for the sake of argument, let’s take a look at the bet being offered. The underwriter seems to be betting that the Euro Stoxx 50 index is going down. Each month that it trades at less than 80% of its value when the structured product is rolled out, the buyer of a bond tied to the index would receive no monthly payment. Otherwise, he gets a monthly coupon (whose value is 7% ann. for the first five years).

There is an ETF that tracks the index, as well as options chains on that EFT, and probably futures for the index, as well as options on those futures contracts. So there’s lots of ways to recreate a “home brew” version of the bet. But let’s take the simplest case, that of making an unleveraged, directional bet on the underlying itself. And let’s benchmark the index (represented by FEZ) against a comparable US counterpart (such as SPY or DIA). http://finance.yahoo.com/echarts?s=FEZ+Interactive#symbol=fe...

Clearly, the EuroStoxx50 (aka, FEZ) is more volatile than DIA or SPY, which means it’s more tradable. So let’s drop down to a shorter time frame. http://finance.yahoo.com/echarts?s=FEZ+Interactive#symbol=fe... If the would-be buyer of the bond had done nothing more than go long on a cross of Price over a 20-period SMA, he/she could have pulled in 14%, right? or twice the yearly coupon. Similar money could have been made going short. http://finance.yahoo.com/echarts?s=FEZ+Interactive#symbol=fe... If those bets had been leveraged (through options, futures, or options on futures), then even better money could have been made *provided* the bets had gotten both the direction *and* the timing correct. But isn’t that also true for the bond buyer? He/she has to get the direction and timing correct, or else they’ve merely made an interest-free loan to the bond issuers.

If you buy the structured product, you think you are excused from doing your homework. But you can bet that your counter-party has done theirs, and you can bet that you will lose any bet you make with a more well-informed counter-party. However, da, da, you could become your own counter-party by putting together a set of trading rules that would have as its goal a minimum return of 7% per year. And having built that tool, you could apply it more widely than to just the single index.

That’s why buying ready-made products is so harmful. It induces laziness and sloppy thinking. You become so bedazzled by the upsides that you forget about the downsides. But if you make the effort to see how/where they intend to profit and do a knock-off, then you gain both knowledge and, possibly, some fat profits.
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That’s why buying ready-made products is so harmful. It induces laziness and sloppy thinking. You become so bedazzled by the upsides that you forget about the downsides. But if you make the effort to see how/where they intend to profit and do a knock-off, then you gain both knowledge and, possibly, some fat profits.

I definitely agree with you on the use of the step-up interest rates to "bedazzle you by the upside." In my own quickie analysis, I don't see how you ever collect the 15%. The index has to pretty much tread water for 20 years. If one was bullish on Europe, one could put money in the notes and collect 7% for five years before the notes would be called. No one, however, is really bullish about Europe right now. It's questionable whether the Euro currency will continue to survive given the current problems of most European nations aside from Germany. So the question is does the index stagnate or does it begin to sink in the near future? Morgan Stanley is betting on the latter and I think they're right.

It's far better to stick with traditional products like stocks and bonds where the issuer's and investors' are more or less in line. Both want the underlying company or fund to go up in value. The adversarial relationship between issuer and investor when it comes to structured products is more like that between a Casino and its clients.

Oh well...the hunt for income goes on... Thanks to all who replied, especially Charlie! I appreciate candor!
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It's far better to stick with traditional products like stocks and bonds where the issuer's and investors' are more or less in line. Both want the underlying company or fund to go up in value. The adversarial relationship between issuer and investor when it comes to structured products is more like that between a Casino and its clients.

folgore,

That's a brilliant summary of this thread. Good job!

Charlie
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The following appeared in my email box just now.

For investors who place a priority on principal protection, but who wish to maintain some exposure to the markets, Market Linked Certificates of Deposit (MLCDs) may represent an innovative alternative in today's uncertain economy. MLCDs offer principal protection when held to maturity (up to $250,000 of which is insured by the FDIC), but also offer potential returns based on the performance of various market measures, such as gold, silver, equities, commodities, or a basket of foreign currencies. Euro Pacific Capital began offering these products to our clients in 2012.

Currently, we are offering four MLCDs for the month of February (each with a minimum investment of $25,000):
1. The first tracks a basket of 10 commodity indices
2. The second tracks a proprietary long/short commodity strategy
3. The third tracks a basket of four currencies (BRIC) Brazil, Russia, India, China vs. the US dollar
4. The fourth tracks the performance of gold spot price
These products will be open for investment through February 22, 2013. We will continue to offer new products on a monthly basis.


Frankly, I have mixed feelings about this. I’ve got a lot of respect for Peter Schiff (the owner of Euro Pacific Capital). He’s a thoughtful, careful analyst. But the funds his company offers are another matter. They don’t do badly compared to their peers. They just don’t do exceptionally well, which I suspect is how these market-linked CDs would turn out. But I also suspect they will sell well, because investors are getting panicky about what lies ahead for markets, and the drumbeats of 4% investment returns for the rest of the decade are becoming louder. http://finance.yahoo.com/blogs/breakout/investors-must-lower...

About these products I’d make the same comment that I did about the Morgan Stanley Euro 50 Stoxx structured product. Consider the underlying investment thesis, and try to see if you can do a knockoff whose risks and rewards you control, not your counter-party.

Charlie
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