Summer 2007

Insights for
Preferred Clients
Structured Products:                      For years, we’ve been told that
Summer 2007

specific objectives. Furthermore, they can      index. At maturity, you are guaranteed a     year, you coul...
Summer 2007

alternatives to indexing,” says Glicksman.     Leverage Strategies                         It is crucial t...
Summer 2007

The information contained herein is provided for illustrative purposes only and is not intended to, nor sh...
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Structured Products: Tailoring Risk to Meet Investment Needs


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For years, we’ve been told that managing wealth successfully requires balancing portfolios to manage risk efficiently. But what if you had the ability to customize the level of risk to match your unique investment objective or market expectation?

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Structured Products: Tailoring Risk to Meet Investment Needs

  1. 1. Summer 2007 Insights for Preferred Clients Structured Products: For years, we’ve been told that managing wealth successfully has an AA+/Aaa credit rating from S&P and Moody’s, and we conduct thorough Tailoring Risk to Meet requires balancing portfolios to manage risk efficiently. But what if due diligence on third-party providers to make sure they are up to our standards.” Investment Needs you had the ability to customize the level of risk to match your unique investment Different Exposures objective or market expectation? Structured products are securities Since the 1980s, structured products designed to provide different exposures have been popular risk management A more precise way to match your risk to direct investments in a range of asset tools for institutional investors, such tolerance and time horizon to your classes—from stocks, bonds and other as insurance companies, pension funds investments would help assure that your fixed-income products to alternative and large university endowments. asset allocation provided the best investments in commodities, currencies, protection in both up and down markets. private equity, venture capital and even This is why a new hybrid brand of hedge funds. They possess unique risk- securities known as “Structured return profiles and can be strategically Products” is gaining in popularity as a employed within an asset allocation way to help achieve those objectives. In program to help manage overall portfolio the United States, structured product volatility. sales grew by 33% last year, to a total of $64 billion, according to the Structured Structured products are “synthetic” in Products Association, an industry trade that they provide exposure to various group. They work by blurring the lines asset classes and specific investments between asset classes. That enables you through derivative securities. They utilize to pursue strategies that may align your options, futures and warrants (options appetite for risk, need for income or issued by a financial institution or overall market outlook with your wealth corporation) on an underlying security, management objectives. index or alternative investment. Because of their flexibility, structured products “We try to find alternative ways to gain offer the ability to modify the risk and exposure to an asset class with some return profiles of the underlying kind of cost or tax efficiency and with a investments, with the goal of enhancing risk-adjusted return that’s as good as, or gains or providing principal protection. better than, what is achievable through a direct investment,” says Jorge Ramirez, Structured products are issued as notes Executive Director of Structured Product with a specified maturity, usually Development at UBS Wealth between one and five years. They Management. typically carry the credit quality of the issuing firm, so the firm’s credit rating is “At UBS, we operate from an open- a critical consideration. architecture platform to obtain competitive pricing and overall value Playing Offense and Defense from a variety of issuers that include Structured products can be used major investment banks,” notes Ramirez. aggressively or defensively in a portfolio, “Many notes are issued by UBS, which depending on the type of note and your abc
  2. 2. Summer 2007 specific objectives. Furthermore, they can index. At maturity, you are guaranteed a year, you could sell some of your shares vary in complexity. They can be linked to return of your principal—as you would of that stock and purchase a one-year movements in an underlying index, or to with the bonds—but instead of receiving yield optimization note that pays a 10% ideas generated by UBS Wealth a regular fixed coupon each year, you coupon, and has contingent protection Management Research that lead to would receive an additional payment at with a trigger price of $75. investments for various scenarios—from maturity based on the percentage gain of movements in the U.S. dollar, the the index over the five-year period. If the outcome is as you had expected direction of interest rates and the shape and the stock returns less than 10% but of the yield curve, to the outlook for If the index gains 50% over the term of never closes below $75 during the term lenders of sub-prime mortgages. the notes and you had invested $1,000 of the note, you will receive your in the notes, your additional payment principal back and get a 10% return “With such a wide range of investment would be $500, which is equivalent to an from the coupon on the note. If the possibilities, it’s helpful to establish annualized return of 10%—versus the stock does fall below $75 at the close of logical groupings,” states Eric Glicksman, 5.5% you would have earned in bonds. any day during the term of the note, Managing Director at UBS Wealth As with all types of notes linked to an you’ll end up with your $10 from the Management and Head of Product index or a single stock, you forego the coupon payment and receive a share of Development for Structured Products. payment of dividends for the term of the underlying stock at maturity. If the “We’ve placed the structured products the note. stock makes a turnaround and rallies to into four broad categories based on $125, you will have earned a 35% return common characteristics and different Optimization Strategies ($25 gain plus $10 coupon). If it levels of risk and return: protection, Yield optimization notes are potentially continues to head south and closes at optimization, performance and leverage.” attractive alternatives if you have a $50, your return will be negative 40% (a moderately bearish to moderately bullish $50 loss offset by the $10 coupon). Protection Strategies outlook on a stock. If you believe that Among the more popular types of the stock will trade within a certain Another type of optimization solution for structured products are principal range for a period of time, a “Yield a range-bound security, known as a protection notes. They generally provide Optimization Note with Contingent “Return Optimization Security,” offers exposure to an underlying investment’s Protection” may be a solution worth leveraged upside exposure up to a price appreciation while offering either considering. It provides some downside maximum percentage. For instance, you full or partial protection of principal protection and pays an above-market may hold a moderately bullish view of an if the notes are held to maturity. Principal coupon in exchange for initially sacrificing exchange-traded fund (ETF) representing protection notes are often linked to one gains in the investment that may be a particular market sector. or several major equity indexes (such as above the coupon rate. the Standard & Poor’s 500 Index®). They A Return Optimization Security may are usually used to help reduce portfolio The “contingent protection” feature provide for three times the percentage risk while still maintaining an appropriate provides for the return of your principal gain of the same index to which the ETF allocation to stocks. in cash if you hold the note to maturity, is benchmarked over the term of the as long as the underlying stock never note. Your maximum possible return “Although the underlying investment closes below a predetermined “trigger” might be capped at 18% and you have may be in stocks, commodities, rates or level at any time during the term of the no downside protection. If the ETF gains even currencies, because of their risk note. If it does close below the trigger 5% over the term, for example, your characteristics these types of notes price, you’ll receive shares of the stock at return would be 15%. If it declines, are typically considered strategic maturity, which may be worth more or however, you participate fully in any loss. complements to traditional fixed-income less than the price of your initial investments,” observes Glicksman. investment. As a result, you can lose Performance Strategies money, but you enjoy a “dual buffer” Performance notes offer strategic and For example, say you have a portfolio of against negative returns because of the efficient access to a wide range of bonds with an average maturity of five coupon and the contingent protection underlying investments, from stock years that is yielding 5.5%. If you were down to the trigger level. indexes to commodity baskets and aiming to achieve potentially higher alternative investments. They can also yields, you could invest a portion of your As an example, you might hold a growth offer leveraged upside exposure as well portfolio in five-year, 100% Principal stock that trades at $100. If you believe it as partial principal protection in some Protection Notes linked to an equity won’t gain more than 10% over the next cases. “These are designed as strategic 2
  3. 3. Summer 2007 alternatives to indexing,” says Glicksman. Leverage Strategies It is crucial to understand—and be “They can magnify gains on the upside Some structured products offer leveraged comfortable with—the risks you’re taking while mitigating downside risk in a tax- exposure to underlying investments— when using leverage in the market. efficient manner.” everything from indexes to commodities, Structured products can be used to fill foreign exchange rates and hedge funds. gaps in your portfolio while offering For example, five-year Performance The term “leverage” simply means that better definitions of risk and return Securities with Contingent Protection can you’re putting up only a portion of the tradeoffs. As such, they can prove be structured on an index to provide you value of the underlying security to tremendously valuable in helping you to with 130% of the positive returns of the participate fully in its price movements grow and preserve your wealth. index (with no cap). Your principal is fully over the term of the investment. protected if you hold the note to maturity, Because structured products can be if the index never closes below a 50% The risk of using leverage to pursue complex in their construction, your trigger level for the duration of the note. gains is that you could lose all of your UBS Financial Advisor will work diligently investment should the market move in to ensure that they are a good fit for If the value of the index is 50% higher the wrong direction. The upside is that your needs. at maturity, your return would be 65% you’re able to achieve potentially large (1.3 x 50%). Should the index close 50% price gains by risking a comparatively below its initial value at the close of any smaller amount of capital. day during the term of the note, the contingent protection feature disappears “Using leverage can be an aggressive and you are fully exposed to any losses. strategy,” declares Ramirez. “But since You would receive a payment in cash that you’re putting down potentially only reflects the change in the value of the 25% of the value of the securities you’re index over the five-year period—which controlling, you can use the other 75% may be higher or lower than your initial to invest in less risky investments.” investment. About the Contributors Eric E. Glicksman, Managing Director, Jorge A. Ramirez, Executive Director, Structured Products UBS Structured Products Development Eric joined UBS Wealth Management US in June 2006 Jorge A. Ramirez is a member of the UBS Structured as Managing Director and Head of Product Development, Products Development team at UBS Financial Services Inc. Structured Products. and is responsible for new business initiatives and new product development. Before joining UBS, Jorge Previously, Eric was Managing Director in the U.S. Equity developed equity-linked and hedge fund-linked structured Derivatives group at Citigroup’s Corporate and Investment products at Goldman Sachs, Wachovia and Lehman Banking division. Before that, he was Managing Director, Brothers. He earned his B.A. in economics and political Head of Equity and Fund-linked Structured Products and science from Swarthmore College and his J.D., the Hedging and Monetization groups at Wachovia cum laude, from the NYU School of Law. Securities Corporate and Investment Banking division. Eric holds a B.S. and a master’s degree in mechanical engineering from the University of Michigan. 3
  4. 4. Summer 2007 The information contained herein is provided for illustrative purposes only and is not intended to, nor shall it be deemed to, constitute an offer to sell, or the solicitation of an offer to buy, securities. The returns on the Structured Products described here are linked to the performance of the underlying instruments. Investing in Structured Products is not equivalent to investing directly in the underlying instruments. Structured Products are sold by prospectus only. Investors should contact their financial advisors for more information. Investing in Structured Products involves risks. Investors should carefully read the detailed explanation of risks, together with other information in the relevant offering materials. As a firm providing wealth management services to clients in the U.S., we offer both investment advisory programs and brokerage accounts. Advisory services and brokerage services are separate and distinct, differ in material ways and are governed by different laws and separate contracts. For more information, please visit our website at Neither UBS Financial Services Inc. nor any of its employees provide legal or tax advice. Investors should consult their personal legal or tax advisor regarding their personal circumstances ©2007 UBS Financial Services Inc. All Rights Reserved. Member SIPC. All other trademarks, registered trademarks, service marks and registered service marks are of their respective companies. UBS Financial Services Inc. 070627-2210-V148 UBS Financial Services Inc. is a subsidiary of UBS AG.