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Reading the fine print: since 2001, the market for structured investment products grew rapidly as investors lost faith in equities. Now, these so-called 'safe' retail investment products are fighting to salvage a reputation dented by financial chaos and customer losses. Below, we examine a variety of investment options currently available.

These structured investment products, or derivatives, with reassuring elements in their names like 'discount' and 'guarantee', allow investors to gain exposure to equities or other asset classes with benefits that include more leverage or guaranteed bonuses if markets remain stable. Unfortunately, markets haven't been stable.

Money has been withdrawn as equity markets have dived. And, the collapse of Lehman Brothers has intensified the problem. Investors with certificates issued by Lehman now face a long wait to recover part of their money, which is not covered by bank guarantees.

Lehman is not the only bank failing to deliver, and many investors have become disillusioned. The yields on 'risk-free' assets are now at record lows and are spitefully referred to as 'return-free risk assets' in financial circles. Most investors bought the products from third-party banks, and lawyers representing investors believe many were badly advised and might not have realised the true risks--or even who the issuers were. Despite this, a judge recently dismissed a claim against the Frankfurter Sparkasse from a couple that claimed they had been badly advised by buying Lehman products.

Credit Suisse's structured investment products carry the following warning: "Complex products require sufficient knowledge, experience and professional advice to make an evaluation of the merits and risks. Investors should consult their own business, tax, legal and accounting advisors with respect to this investment and should refrain from entering into an investment transaction unless they have fully understood the associated risks and have independently determined that the investment is appropriate for them.

So--Caveat emptor! Let the buyer beware. In hindsight this advice is logical but in practice, customers expect a product that offers 100 per cent capital protection.

What's your preference?

Currently, annual interest rates on regular private accounts are around 0.2 per cent, and around 0.7 per cent on savings accounts. Two-year Swiss franc bonds are paying about one per cent per year.

These are extraordinary times, thus many believe derivatives will continue to offer advantages over mutual funds, such as focused exposure to particular asset classes. To win back the trust of the conservative investor, many market participants expect there will soon be more transparency--meaning the products must be simple enough for an investment consultant to explain and the client to understand.

Equity markets have plummeted and it is widely agreed that while the real economy will worsen, the recession is already reflected in today's equity prices. Most capital-protected products are successful--providing equities do not lose more than 40 per cent of their value over an agreed-upon time period. Let's look at a few of the investment products and options currently available:

13.00% CHF LastLook Equity Yield Note

The LastLook Equity Yield Notes are structured derivatives. These notes are suitable for clients looking for a regular income and satisfied with a neutral performance of each underlying instrument. Recently a note was offered using Nestle, Novartis and Roche as the underlying instruments.

How it works: During its lifespan, this LastLook Equity Yield Note pays a fixed semi-annual coupon of 13 per cent per annum. If none of the share prices of the three companies close at or below each of their pre-agreed barriers at the final fixing date, the redemption amount for the LastLook Equity Yield Note will correspond to 100 per cent of the denomination.

So far, so good. However, if at least one of the underlying companies' share price closes at or below its individual barrier on the final fixing date, the client will receive the worst-performing title at the pre-agreed conversion ratio. The investor also has to bear the usual transaction fees when the redemption amount is paid out.

Credit Suisse advertises this as an investment with 100 per cent capital protection. However, it also adds "the investor bears the risk that the issuer of this investment product may become insolvent, which may lead to a partial or total loss of the invested capital in case of insolvency of the issuer. The Capital Protection does not protect the investor from such losses."

In this example, for Swiss income tax purposes, the coupon payment of 15 per cent per annum is split into two parts: the interest payment of 0.73 per cent--which is subject to Swiss income tax, and the premium payment of 12.27 per cent which qualifies as a capital gain and is therefore generally tax-free.

5-year, 1.90% Step-Up Note in CHF--(2009 to 2014).

The Credit Suisse Step-Up Notes are structured derivatives and belong to the capital protected units category. This note is an interesting alternative for investors who do not expect interest rates to rise above the scheduled coupon rates. Re coupon steps up over the lifetime of the note.

In the first year, the note pays a fixed, semi-annual coupon of 1.9 per cent. Thereafter, the coupon increases (or steps up) annually by 0.25 per cent, to 2.9 per cent in the last year. Capital protection means the issuer is obligated at maturity to repay the initial capital investment at the protected level of 100 per cent.

The Step-Up Note may trade at a considerably lower value than the protected redemption during its lifespan, and is therefore suitable for the customer who does not require the money for five years. At maturity, the issuer has the obligation to repay the initial denomination at 100 per cent (full capital protection). If interest rates rise above the predefined coupon rates, you will not benefit from this upside performance.

In addition, those who invest in these products bear the risk of the issuer of the investment product becoming insolvent, which could lead to a partial or total loss of the invested capital. The capital 'protection' does not protect the investor from such losses.

Cantonal banks

The cantonal banks are back in favour, since most have a 100 per cent state guarantee that applies to their own investments. Most other banks have an underwriting guarantee between SFr 30,000 and SFr 100,000.

For example, the Luzerner Kantonalbank currently offers a capital-protected note through its partner, the Rabobank. The Rabobank--even in this financial climate--has retained its AAA Standard and Poors rating.

Capital Protected Note on the Swiss Leader Index (2007 to 2012)

For investors who prefer a top-rated bank and also wish to invest in the Swiss market, the Capital Protected Note on the Swiss Leader Index (2007 to 2012) is worth a second look. The Swiss Leader Index (SLI) includes the 50 companies with the most liquid shares traded on the Swiss equity market.

Please note, this article is for information purposes only. The investments mentioned may not be suitable for all investors. Therefore, please consult a financial advisor before investing.

Brien Donnellon is the owner of KEY INVESTMENT, a financial services company providing unbiased financial advice and solutions for Swiss-based expats, HR departments and foreign investors.

The company, formed in 1997, is authorised and regulated by the Swiss Federal Banking Commission.

For further information please visit: Or you can email, or call 081 257 13 14.
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Title Annotation:MONEY
Author:Donnellon, Brien
Publication:Swiss News
Date:Mar 1, 2009
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