Structured Products and Autocalls: How They Work and Where the Risk Sits

A structured product is a note issued by a bank whose return is set by a formula. The formula is linked to something else: a share, a basket of shares or an index. You do not own those underlying assets. You own a promise from the issuing bank to pay you according to the formula.

The most common type offered to private investors is the autocall. The name comes from the fact that the note can be called, meaning repaid early, automatically.

How an autocall works

An autocall has a maximum term, often five or six years, and a series of observation dates along the way. On each observation date the product looks at where the underlying assets are compared with where they started.

• If they are at or above the trigger level, the note ends early. You get your capital back plus the coupon for the period it ran.
• If they are below the trigger, the note carries on to the next observation date. In many designs the missed coupons are remembered and paid later if a trigger is eventually met.
• If the note reaches its final date without having been called, what you get back depends on a capital barrier.

The barrier is the part that matters

The capital barrier is a level, set well below the starting level, that the underlying assets must stay above at the final observation for your capital to be returned in full. If the worst-performing asset finishes below the barrier, your capital is reduced in line with its fall. A share that has fallen by half takes half your capital with it.

Two details change the risk considerably. First, most baskets work on a worst-of basis: the outcome is decided by the single weakest asset, not the average. The more names in the basket, the more chances that one of them breaches. Second, check whether the barrier is observed only at the end or continuously through the term. An end-of-term barrier is more forgiving.

The risks behind the formula

• Issuer risk. The note is an unsecured obligation of the bank that issues it. If the bank fails, the formula is irrelevant.
• Market risk. A breach of the barrier produces a real capital loss.
• Capped upside. If the underlying shares rise strongly, you receive the coupon and nothing more.
• Liquidity. A secondary price may be available, but it can be well below what you paid, particularly in falling markets.
• No dividends. You do not receive income from the underlying shares.

When an autocall makes sense

Autocalls suit an investor who expects the underlying assets to be flat or modestly higher, wants a defined return for that view, and can accept a loss if the view is badly wrong. They do not suit someone who needs the capital at a fixed date or who is treating the coupon as guaranteed income.

Before investing, read the term sheet for five facts: the issuer, the underlying assets, the autocall trigger, the barrier level and how it is observed, and the maximum term. If you can state those in one sentence each, you understand the product.

This article is general information, not personal advice or an offer of any investment. The value of investments can fall as well as rise and you may get back less than you invest. Private credit, structured products and unlisted bonds are higher-risk and are only suitable for investors who can afford to lose the capital they commit. Speak to a qualified adviser about your own circumstances before acting.