LET the buyer beware, says the old maxim.

TNP PHOTO ILLUSTRATION: SIMON ANG

But first, shouldn't the buyer be made aware?

All information about costs, risks and returns need to be in the prospectus. That is Step One.

If it is not there, it is very hard to move onto Step Two: Getting investors to read it.

Which is it?

Is all important information in the prospectus? Or is it missing?

I will get to that in a minute.

Cheap capital

Structured products have been a cheap way for investment banks to raise capital.

It is because risks appear low while returns look high, making them easy to sell.

But is that information accurate?

I have found it is not.

Important risk and cost information is missing from the prospectus, according to my research.

1) First is the risk of total loss, caused by a credit event. The prospectus understates it by showing individual risks.

This is not correct since the first-to-default nature of these products makes the risks additive, making them higher.

2) Second is the risk of partial loss, caused by a decline in the value of the underlying assets.

It is also understated in a subtle way.

The prospectus states that the linked notes invest in AA debt securities.

Those are very safe unless the AA debt securities are collateralised debt obligations (CDOs).

Then they are quite risky, which is the case for many credit and equity-linked notes.

The prospectus fails to mention this important qualification.

3) Third are costs.

No credit-linked structured product has ever revealed any information about its charges.

The result: Investors pay the issuing bank's charges without ever knowing it.

Why did we buy so many?

We bought billions of dollars of these over-blown structured investments. Why?

The reason, I think, is because banks, brokers and advisers appeared reassuring. They had three points of persuasion:

1) First is the prospectus. It is key to everything.

Investors under-rated the risks because the CDOs were AA-rated.

Investors assumed costs were low too since none were mentioned in the prospectus, fact sheet, brochure or anywhere else.

2) Second is the ever-present warning to seek financial advice.

Of course, the bank's relationship managers (RMs) were immediately available to provide it.

The problem is RMs must meet the bank's quotas to keep their jobs.

The conflict continues to this day.

We may never know the extent of it.

Banks still decline to reveal their sales and product quotas for RMs.

3) Third, until this year, there was a feeling that financial engineering really worked.

Somehow, re-structuring could magically take away risks without reducing returns.

Sorry, but it's wrong. It's like the law of conservation of matter.

Yes, it is easy to change matter to energy and back again.

But it is not possible to change the sum of the two.

What was there at the beginning of time will be there at the end.

Nothing is added. Nothing gets taken away.

The same applies to risks and returns in a diversified portfolio.

It is not possible to increase an investment's returns without decreasing its safety.

No way. No how.

Not even with fancy financial engineering.

So, who is to blame for the enormous losses in credit and equity-linked structured products?

Is it the buyer for failing to beware?

Or is it the issuing banks and distributors for not making us aware of critical information?

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