High Yields, Hidden Risks: Why Structured Products Favour the Seller
It’s the holy grail of investing: enjoy the upside of the stock market, but avoid the downside. In a world of uncertain returns, that proposition is hard to resist. Many retail investors are drawn to products that promise just that—especially structured products. These cleverly engineered instruments are typically sold by private banks and offer tailored payoffs that sound too good to ignore: capital protection, enhanced yields, and equity exposure with limited risk. But behind the marketing lies a different story. Structured products are often built to benefit the issuers, not the end investor. In this post, we unpack the hidden costs, embedded conflicts, and academic findings that reveal why structured products are a source of substantial profits—for the issuers not the end investor.
What Are Structured Products?
Structured products are pre-packaged investment vehicles, typically combining a bond component (to offer capital protection) with derivatives (to engineer market exposure). For example, a common product might promise a 9% annual yield as long as certain stocks don’t fall below a threshold. Others offer partial downside protection with capped upside.
At first glance, they appear to meet the rational investor’s dream: some level of safety, coupled with upside potential. But as Rational Reminder host Ben Felix notes in their AMA #7 episode, these products are rarely as investor-friendly as they sound. Most are highly complex, difficult to assess on an expected return basis, and littered with opaque costs.
Yield Enhancement Products (YEPs)
A particularly common form of structured product, especially in the UK and other developed markets, is the Yield Enhancement Product, or YEP. These are marketed with a similar pitch: high yields in a low-rate environment, modest downside exposure, and a promise of capital return under specific conditions. Whilst the name might sound benign—who doesn’t want enhanced yield?—YEPs follow the same design principles as other structured notes: your extra yield is created by taking on hidden risks, usually through embedded options and asymmetric payoffs.
In the UK, YEPs are often sold to retail investors via advisers, discretionary fund managers, and private banks. They typically take the form of autocallables, reverse convertibles, or barrier notes—products that pay a fixed coupon contingent on a reference index or basket of stocks not breaching a pre-set downside barrier. These can include popular names like the FTSE 100, major banks, or other blue-chip equities.
The Problem: Complexity Obscures Cost
One reason structured products persist is because their structure makes them difficult to evaluate. As Felix explains, banks hedge their risk exposure using options and other derivatives when creating structured notes (a type of structured product issued as a debt security). The cost of constructing the hedge is well known to the bank. The trick? Sell the product to the investor at a premium to that cost—and pocket the difference.
Take a specific example discussed by Dan Bortolotti in Rational Reminder AMA #7: a structured note marketed to retail investors promising a 9% annual income, with the assurance that your capital will be returned in full at maturity—provided that a basket of major bank stocks does not fall more than 30% during the term. At first glance, this appears to be a clever, yield-enhanced way to access the stock market with limited downside. But beneath the surface, the structure is far more complex—and heavily skewed in favour of the issuing bank.
Let’s say you invest £10,000 into this note. Here’s how the bank builds it:
First, it uses most of your money—perhaps around £9,200—to purchase a zero-coupon bond. A zero-coupon bond is a fixed-income instrument that does not pay interest along the way. Instead, it is purchased at a discount and pays out a known lump sum at maturity. In this case, the bond is structured to return £10,000 after one year—effectively protecting your capital if the underlying conditions are met and no default occurs. This is how the ‘capital protection’ element is engineered. It’s not magic. It’s just bond maths.
With the remaining £800, the bank constructs the note’s return profile using derivatives—specifically, options. This is where the risk (and profit for the bank) comes in.
Firstly, the bank sells a put option on the underlying basket of bank stocks—and crucially, you, the investor, are economically on the hook for that position. The strike price of this put is typically set 30% below the starting level of the index or stock basket. If the market stays above that level, the put expires worthless and you receive your full coupon and capital back. But if the underlying falls below that 30% barrier—the strike price—the put finishes in the money and you begin absorbing losses, point for point, beneath the barrier. This is how the bank funds your 9% ‘yield’: by collecting the premium from selling that downside protection and using your capital and risk exposure. In effect, you are selling crash insurance—and getting paid for it with a fixed coupon. But unlike owning the underlying shares directly, you receive no dividends, no voting rights, and a capped upside. You are obligated to take the hit if markets decline sharply.
Secondly, the bank sells you a capped call option—this gives you limited exposure to the upside of the bank stocks—up to the 9% coupon. If the stocks rally 15%, 25%, or even more, you don’t get any of those gains. You still receive just the 9% that was promised at the start. The bank, meanwhile, has structured the trade to capture any returns above that cap, either by selling that upside on to another party or hedging it internally at low cost.
So, let’s recap: you’ve surrendered the upside of the market and taken on substantial downside risk in exchange for a fixed coupon. That 9% is not free. It’s your payment for effectively:
Writing cheap insurance on the stock market (via the embedded short put)
Giving away future upside (via the capped call)
The bank, in turn, knows exactly what this structure costs to build—it uses advanced option pricing models to determine the cost of hedging. If it costs them 6% to create, but they sell it to you as a 9% return, they pocket the 3% spread. This is the bank’s economic profit, and they earn it upfront, regardless of how the investment performs.
Another way to think about this is:
If the full structure costs 6% of the notional amount (face value amount), and the investor receives a 9% return, then:
6% is the true economic value of the structure.
The bank has added 3% as a markup—a profit margin.
The investor only receives the ‘headline’ 9%, not the full 12% value that the derivatives could theoretically deliver.
Essentially, the bank is keeping part of the value of the put option premium and the investor’s forgone upside for itself, in the form of a yield spread or embedded margin.
To make this more tangible, let’s walk through some hypothetical outcomes:
In that final scenario, you could lose hundreds or thousands of pounds—even though the product was sold as ‘safe’ and ‘capital protected’. Your capital was only protected conditionally, and that condition has failed.
Most critically, the bank is not exposed to these risks. It has used your money to hedge its position, lock in a known profit margin, and offload market risk back onto you. The ‘protection’ is partial, the ‘income’ is synthetic, and the ‘yield’ is just the option premium repackaged and sold at a markup.
This is how structured products create the illusion of high returns with low risk. They offer appealing narratives—income, safety, customisation—but beneath the surface, they involve complicated trade-offs that are rarely explained clearly. In practice, the bank wins either way. You win if a narrow set of market conditions occur, but carry the downside if things go wrong.
Figure 1. This represents the scenario presented above in chart format.
How Much Do Banks Really Make?
A landmark study by Vokata (2020) examines internal data from a large US bank and finds that structured products were among its most profitable retail offerings. On average, investors paid significant implicit fees through skewed payoffs, with banks earning double-digit profit margins on these notes. The bank’s own funds and structured products stood out as their highest-margin investments—particularly when sold through advisers, who may also be incentivised to recommend them (Vokata 2020).
A related academic paper by Anagol, Kolasinski, and Vissing-Jørgensen (2017) concludes that structured notes consistently deliver negative expected returns for investors once hedging costs and bank markups are accounted for. Investors effectively pay for the illusion of safety and yield through subtle design mechanisms: barriers, knock-ins, caps, and participation rates.
These are not hidden fees in the conventional sense—they’re structural features that create the fee by design.
Fair Pricing Doesn’t Remove Structural Risk
Some sophisticated advisers attempt to protect clients by reverse-engineering structured products using models like Black-Scholes or other option pricing frameworks. Their goal is to ensure that the embedded options—such as short puts or capped calls—are fairly priced and that the bank isn't charging an excessive premium. In some cases, this can lead to bespoke products where the adviser has negotiated better terms, reduced bank margins, or capped fees. Whilst this approach can improve the fairness of the transaction, it does not eliminate the core risk embedded in the structure.
Even with a ‘fairly priced’ structured note, the investor is still writing options—taking on tail risk in exchange for yield, and capping potential upside. The fundamental design remains: the investor earns a return only under specific market conditions, whilst the bank earns a known spread up front. Modelling can reduce overpricing, but it can’t change the fact that you are exchanging liquidity and asymmetry for income. Pricing discipline is valuable, but it’s not a substitute for fully understanding what you are actually buying.
Behavioural Traps: Why Investors Still Buy Them
Behavioural finance sheds light on why structured products remain popular despite poor long-term outcomes. Investors are naturally drawn to products with asymmetric payoffs: high upside and limited downside. These instruments appeal to risk-averse individuals who still want exposure to equities, and to those suffering from recency bias—chasing yield in low-rate environments or fearing a market downturn.
There’s also the allure of complexity. As Ben Felix points out, if your adviser can’t explain in plain English how the product generates returns, that’s a red flag. But ironically, the complexity itself can create a false sense of sophistication and security.
A 2018 paper by Fattinger, Fohlin, and Schürhoff shows that investors regularly misinterpret the risk-return profile of structured products, often failing to grasp the full implications of capped returns, conditional protection, or the pricing of embedded options (Fattinger, Fohlin, and Schürhoff 2018).
So What Should You Do Instead?
Structured products can sometimes serve a purpose—for example, in highly bespoke institutional contexts or for tax-driven solutions—but most retail investors are better served by low-cost, transparent ETFs and diversified portfolios.
If you’re tempted by a structured note, consider the following checklist:
Can I explain the payoff clearly to someone else?
How much does the bank or issuer make on this product?
What are my actual expected returns after fees and limits?
Can I replicate this strategy using ETFs and options myself?
In nearly every case, you’ll find there’s a simpler, cheaper alternative that doesn’t require putting your capital into a product designed primarily for someone else’s benefit.
Final Thoughts
Structured products are seductive. They offer the illusion of safety and performance, wrapped in language that flatters our financial instincts. But once you understand how they’re built—and who they’re built for—the magic starts to fade. Behind every promise of an asymmetric payoff lies a very symmetric reality: the bank wins. Every time.
References
Anagol, Santosh, Adam Kolasinski, and Annette Vissing-Jørgensen. 2017. ‘Structural Performance: Evidence from Retail Structured Products.’ Journal of Finance 72 (3): 1031–70.
Felix Fattinger, Caroline Fohlin, and Norman Schürhoff. ‘Retail Structured Products: Too Good to Be True?’ Working paper.
Rational Reminder. 2025. ‘AMA #7: Structured Notes, Market Timing, and Money-Weighted Returns’. Podcast audio, June 2025. https://rationalreminder.ca/podcast/ama-7.
Rational Reminder. 2023. ‘Episode 261: Felix Fattinger & Petra Vokata — Structured Products: What’s Really Under the Hood?’ Podcast audio, November 2023. https://rationalreminder.ca/podcast/261.
Vokata, Petra. 2020. ‘Paying for the Illusion of Performance: Distribution Fees and Fund Returns’. Journal of Finance 75 (6): 2995–3044.