Why did my "capital protected" product lose money?Some background helps

Protection is a promise from a company, not a property of the money. Read who made the promise, what it covers, and when it applies.

There are four ordinary reasons, and every one of them is written into the document. None of them is a scandal. All of them surprise people, because the word "protected" does work in a brochure that it does not do in a contract.

Did the company that made the promise survive?

This is the big one. A protected note is a loan to a bank with an unusual repayment formula. The protection is that bank's promise to give your money back. If the bank fails, the promise fails with it, and it does not matter at all what the index did.

In 2008, holders of Lehman-issued protected notes found out exactly this. The notes tracked indices that were, in some cases, up. The issuer was gone, and the holders joined the queue of unsecured creditors. There was no separate pot of protected money, because there never is one.

So the first question about any protected product is: protected by whom? Look up the issuer, not the index.

Did you hold it to the end?

Protection almost always means "at maturity". Before that date, the note trades at whatever it is worth, which can be well below what you paid — especially early on, and especially if rates have moved.

The reason is structural. Inside the note is a zero-coupon bond that grows back to 100 by maturity, plus an option. Early in the life the bond part is worth much less than 100, because it has years left to grow. Sell then and you get today's value, not the promise.

What exactly did the wording protect?

Read the number, not the adjective. "Capital protection" often means 90% protection, and losing 10% is the intended outcome, not a malfunction. Sometimes the protection is conditional: it holds unless a barrier is touched, which turns it from a floor into a tripwire — the same mechanism as the bonus certificate.

And protection is almost always nominal. Getting 100 back after six years is not getting your money back if prices rose 20% in the meantime. Inflation is not a market event that the issuer failed to foresee; it is simply outside what was promised.

Was it protected in the currency you spend?

A note protected at 100 dollars is protected in dollars. If you bought it with euros and the dollar fell 15%, you have exactly what was promised and 15% less than you started with. Currency risk sits outside the protection unless the document says it is hedged.

What did the protection cost?

Nothing in a structured product is free; it is assembled from parts, and each part is paid for. The usual price of protection is the dividends. A protected note on an index typically pays the price return only, and a broad index yields around 2% a year. Over six years that is roughly 13% of the return, handed over in exchange for a floor.

Sometimes the price is participation instead: you get 100% protection and 60% of the rise. Sometimes it is a cap. There is always a payment, and the term sheet playbook is about finding where it was made.

What should I check before buying the next one?

• Who is the issuer, and would I lend them money unsecured for six years?
• Does protection apply only at maturity, and can I hold that long?
• Is it 100%, or a number below it, or conditional on a barrier?
• Which currency is it protected in?
• What was given up — dividends, participation, or a cap?

Five questions, all answered on the first two pages of the document. How products fail shows how often the answer to one of them is the whole story.