Structured Product and Mutual Fund: Who Owes the Holder

A pooled scheme holder has a claim on the assets the scheme holds, and what arrives depends on what those assets are worth. A packaged instrument holder has a claim on whoever wrote the instrument, and what arrives depends on a formula in the document being applied by a party who must still be there to apply it. Different things entirely.

The packaged side runs on an invented instrument written on an invented reference asset, and no figure it produces is a price taken from any market or any venue. Three inputs generate all of it: a spot price of Rs 2,000.00/- for the reference asset, financing of 6.50 per cent a year, and a call premium of Rs 180.00/- that is given rather than worked out. A payout during the year would change every figure below, so the reference asset pays nothing at all while it is held. The pooled side carries no figures at all. A real scheme publishes its own, and a made-up unit value put beside these to make the two columns look even is exactly the sort of number a reader carries away and uses.

What does every other difference follow from?

One sentence, and after it the rest is bookkeeping. The difference between these two things is what is standing behind the holder, and every other difference set out below is a consequence of that one. Assets held in a pool are the property of the people holding units in that pool. Those assets sit there whatever anybody else does, and their value is a fact about the assets rather than a fact about anybody's willingness to pay. A promise written into a document is different in kind: it is the obligationSomething a named party has undertaken to do. The obligation exists because that party undertook it, and that party performs it rather than the passage of time. of the party who wrote it, and it exists for as long as that party performs it.

Put in the plainest terms available, a claimWhat a holder is entitled to, and from whom. A claim always has two halves: the thing the holder is entitled to, and the party or the assets it is entitled from. always has two halves. One half is the thing the holder is entitled to. The other half is who or what the holder is entitled to it from. Most of the confusion between these two comes from taking care over the first half and never once looking at the second. Both of these arrangements are sold in the same kind of conversation, both take a payment at the start, and both produce an amount at the end. Only the second half of the claim separates them, and it separates them completely.

What does a person hold when they hold a pooled scheme?

The plainest version of the arrangement has nothing financial in it at all. Ten shopkeepers on one street each have some money set aside and none of them has enough to buy the building they trade out of. So they put their money together, the building is bought, and each of them is written down as holding a stated share of it. The building is theirs. If the person who arranged the purchase, drew up the paperwork and collects the rent walks away tomorrow, the building does not walk away with them. Somebody else will have to collect the rent, and that is an inconvenience rather than a loss of the thing itself.

A pooled schemeMoney put together from many people so that it can buy assets which are then held for all of them together, with each person holding a stated share. is that arrangement, written in securities instead of bricks. Money from many people is put together, the pool buys assets, and each person is recorded as holding unitsA share of a pool. One unit is worth whatever the pool's holdings make it worth, and nobody has promised that amount. representing a share of that pool. The holder's claim is on the assets themselves, and what a unit is worth is worked out from what those assets are worth. Nobody has undertaken to pay the holder an amount. The holder has a share of a pile, and the pile is valued.

A share of a valued pile carries no promise, no formula, no date and no party who has to do anything for the value to be there. Valuing the pool is an act of measurement performed on things that exist. How a scheme of this kind is categorised, what it is allowed to hold, what it may charge its holders and what it must publish are each set by the Securities and Exchange Board of India (SEBI) at sebi.gov.in and are covered separately and in full. The single structural fact in the paragraph above holds across all of that, and it does not change from one category of scheme to the next.

What does a person hold when they hold a packaged instrument?

Now the mirror, defined on its own terms and not by subtraction from the paragraph above. A buyer pays an amount to whoever is offering a packaged instrumentOne instrument, sold under one name at one price, which is owed as several separate promises by whoever wrote it. and receives a document. The document sets out what that party will pay the holder and when. The transaction is complete at that point. The holder's claim is on a party, not on a pile of assets, and what that claim is worth is what the obligations written into it are worth.

The everyday version is a repair contract rather than a building. A customer pays a workshop at the start of the year and in exchange holds a written undertaking saying that if a particular thing happens, the workshop will do a particular job. Nothing has been set aside for that customer. No parts are sitting in a box with a name on them. The customer holds a promise by a named party, and the promise is worth something only if that party is there and does what it said when the day comes.

The obligations inside a packaged instrument are ordinary contracts with names of their own, so an instrument of this kind can be written out as its legsOne of the separate promises inside a packaged instrument. Each leg is an ordinary contract that existed under its own name before anybody sold several of them together.. That claim is shown further down with the actual figures of the invented instrument, where two legs are named, two costs are put beside them and the two costs are added. The only thing that matters at this point is that both legs, whatever they are called, are obligations of whoever wrote them.

What decides the amount that arrives at the end?

Both sides produce an amount at the end, and the two amounts are arrived at by operations that are not the same kind of act at all. On the pooled side the amount is whatever the share of the assets is worth on the day, reached by a valuationThe act of working out what something is worth on a stated day, by looking at what it consists of and what those pieces are worth. of what the pool holds. Somebody adds up what is in there and divides. On the packaged side the amount is whatever the formula written into the document produces when the level of the reference assetThe thing whose level a formula in a document is applied to. The holder does not hold it, and nobody is holding it for the holder. is put into it.

One of those is a measurement of something that exists, and the other is a calculation somebody performs and then pays. Read that twice, because the difference between measuring and calculating decides everything that follows. A measurement can be checked by anyone with the list and the prices. A calculation has to be performed. Performing it is an act by a party, so a party has to be there.

Neither operation says which of the two amounts turns out to be larger, and no structural difference between them ever could. Answering that needs an outcome, a probability or a distribution, and the difference between measuring and calculating supplies none of the three. Neither measurement nor calculation is the sounder word either. Letting one sound solid and the other flimsy smuggles a verdict in through the vocabulary.

Who has to be there at the end for each of them to pay?

One difference matters more than any other, and this is it. On the pooled side, the assets are held for the people holding units, and their existence does not depend on the party that arranged the scheme continuing to trade. The ten shopkeepers again: the building stands whether or not the person who drew up the paperwork is still in business. Arrangements exist for what happens to the paperwork in that case and they are set by SEBI at sebi.gov.in, but the thing itself is not a promise anybody has to keep.

On the packaged side, somebody has to perform. An amount arrives at the end because a party undertook that it would and then did what it undertook. So the question who owes this amount has an answer, and the answer has to be read off the document rather than guessed from the name on the front. Needing a party to perform is not a warning and not a criticism of the arrangement. Naming the party describes what kind of thing the instrument is, and the description holds equally for a promise anybody would call unimpeachable and one nobody has looked into.

On one of these, the question a holder must be able to answer is what the pool holds; on the other, it is who owes the amount and what stands behind that promise. Both questions have answers. Neither answer is available from the name of the thing, from the person who sold it, or from how the conversation felt. And the two questions are not interchangeable. Asked of the wrong side, each produces an answer that sounds like it settled something, which is worse than no answer at all.

What can be taken apart on paper, and what has to be looked up?

Here the two sides part company in a way that can actually be acted on at a table. The packaged instrument is written over legs, each leg is an ordinary contract, and each of those contracts has a price somebody quotes. So the parts can be priced and added up, and the addition is arithmetic rather than opinion. Two legs, two costs, one sum, and the figures for the invented instrument are worked through in the section below.

On the pooled side there is nothing to take apart in that sense at all. Nobody wrote any legs into it, so there are none. The pool holds what it holds and publishes what it holds, so the equivalent work is reading a list rather than pricing a set of obligations. A reader who sits down determined to decompose a pooled scheme into its legs is looking for parts that were never written, and will conclude either that the scheme is hiding something or that something has been missed. Neither is true. The parts do not exist because the thing was never assembled out of parts.

One of these is looked up and the other is added up. Both are examinable, and neither operation is the more rigorous one. The difference is only which operation the work calls for. An analyst who arrives with the wrong operation does a great deal of careful work and ends up with nothing. That outcome is more common than being told a lie.

What do the two sides look like when the figures are put in?

Only one side of this comparison carries figures. The packaged side comes first. A buyer pays an outlay of Rs 2,000.00/- and holds a document written over two legs: a promise to pay Rs 2,000.00/- at the end of one year, and a call on the reference asset struck at Rs 2,000.00/-. Financing costs 6.50 per cent a year and the reference asset pays nothing while it is held.

A repeated figure that nobody explains gets read as a mistake, so the repetition below needs a word. Three separate quantities here are Rs 2,000.00/-, and they agree for three separate reasons. The spot price of the reference asset is Rs 2,000.00/- because that is the spot price. The strike is Rs 2,000.00/- because this option leg is struck at the money, and that is what at the money means. And the outlay is Rs 2,000.00/- because this example has the buyer put in exactly the value of one unit of the reference asset. Nothing was copied from anywhere into anywhere else.

Now the parts can be priced. The promise leg is arithmetic: Rs 2,000.00/- due at the end of one year, brought back at 6.50 per cent, is Rs 2,000.00/- divided by 1.065, or Rs 1,877.9343/- today. The call premium is Rs 180.00/-, given rather than worked out. Working it out would need a measure of how far the reference asset moves, and that measure is not one of the three inputs. Every figure on the packaged side is either arithmetic on a rate or a premium that was handed over, and each of them is named as one or the other every time.

Then the sentence the whole comparison turns on, and it is not about the arithmetic at all. Both of those legs are obligations of whoever wrote them. And the Rs 2,000.00/- of reference asset the call is written on is exposureThe value of the thing a contract references. Nobody has paid it and nobody is holding it. An amount that actually changed hands is a different thing., being the value of the thing the contract references, which nobody has paid and nobody is holding on the holder's behalf. An outlay is an amount that moved; exposure is the size of the thing a contract points at, and the two being the same number here makes the distinction harder to see rather than easier.

The other side of the table stays empty. The pooled side is described in shape and never in figures. The published figures for it live in the scheme's own published documents and with SEBI at sebi.gov.in. Filling the column in to balance the table would put a made-up unit value in front of a reader, and made-up unit values are the ones that get used.

Where does the charge sit in each of them?

The two sides carry the charge in different places, and each side is exact about something different. On the pooled side, what the arrangement costs its holders is a stated charge against the pool, and it is published. Its level and its limits are set by SEBI at sebi.gov.in. The limits move and they differ by category, so a level carried from memory is wrong rather than merely out of date on the day it changes.

On the packaged side, the price asked less the cost of the parts is where the packaging is paid for. That is a subtraction rather than a figure. No issuer, no offered price and no fee is stated, so the second term of that subtraction has no value and no amount is put on it. Two figures would fill it in, and both are obtainable from the person offering the instrument: the price actually asked, and the cost of each leg on that same day.

Two readings of that subtraction go wrong. The cost of the parts worked out above holds at these three inputs on one date, and says nothing about what any leg costs anywhere else. And a gap being drawn is not a gap being called large. On one side what it costs its holders is a figure a holder can read off a published document, and on the other it is a figure a holder would have to work out by pricing the parts on the same day, and saying that is not the same as saying either figure is big or small.

On what are the two not compared, and why?

Every difference so far fits in one table. Read down it and notice what every row has in common: each one is a structural difference, and not one of them is an outcome.

No structural comparison says which of the two is better, which has paid more, or which one a person ought to hold. The silence is not a posture, and a reason is worth more than a posture because a reason can be checked. Each of those three questions needs an outcome, a probability or a distribution, and no structural difference produces any of the three. The three inputs behind the packaged instrument generate arithmetic and nothing else: no history, no chance, no distribution. A structural description tells a holder what they are holding, and stops there.

Nor does a structural comparison support the conclusion that the packaged side is one to keep away from. Anybody who has just finished working out how the parts add up reaches for that conclusion without noticing, and it is advice as surely as the opposite conclusion would be. Naming a structural difference is not a verdict. A claim against a party is a perfectly ordinary kind of claim, and so is a claim against a pile of assets. The two are simply not the same kind, and a holder who has confused them will check the wrong thing.

Whether any particular person should hold one of these turns on four things, and not one of them is a structural difference: who owes the amount and what stands behind that promise, what the parts cost on the day the instrument is offered, what leaving before the end date would cost, and the circumstances of the person asking. The first three are questions with obtainable answers, addressed to the person offering the instrument.

How does somebody with two documents in front of them read them?

All of the above turns into five minutes of work at a table, and a lender, an analyst, a person advising a household or a household doing it for itself all perform the same five minutes. The work produces a description of what is held rather than a view on it, so it can be written down and shown to somebody else.

1. What the claim is against, written at the top of each document Two words will do. Assets, or a party. If neither of those two words can be written from the document itself rather than from what was said in conversation, that is the first thing to go back and ask about, and it is a question with an answer.
2. On the side where the claim is against assets, get the published list Then the work is reading, and it is reading a list of holdings rather than pricing anything. What such a scheme must publish and how often is set by SEBI at sebi.gov.in, so the routine is to find that requirement and then ask for what it names.
3. On the side where the claim is against a party, list the legs and put a cost beside each Mark each cost as arithmetic or as a quote from somebody. On the invented instrument here the promise leg is arithmetic, at Rs 2,000.00/- divided by 1.065, and the option leg is a premium of Rs 180.00/- that was given. A note that cannot say which of the two any figure is has not finished the work.
4. Write the name of the party who owes each leg beside it This is the column with no arithmetic in it and it is usually the one that decides how much the rest of the columns are worth. Careful discounting of a promise says nothing at all about whether the promise will be performed.
5. What could not be filled in, written down as questions rather than as gaps The price actually asked, the cost of each leg on that same day, what leaving before the end date would cost, and what stands behind each promise. All four are things a person somewhere knows, and none of them appears in general notes of any kind.

The sequence produces a description, not a verdict, and it runs the same way whichever of the two documents turns out to be in front of the reader. The single thing it protects against is doing the pooled side's work on the packaged side's document, and that is why the first step is the two-word one.

Who sets what must be told to a person before they are sold one?

The structure and the arithmetic hold wherever the arithmetic is carried out. The requirements sitting around both of these arrangements do not travel. Each is set by the authority named beside it, each of them changes, and a requirement written out from memory would be wrong rather than merely dated on the day it moved.

The packaged instrument, the reference asset, the spot price of Rs 2,000.00/-, the strike of Rs 2,000.00/-, the outlay of Rs 2,000.00/- and the call premium of Rs 180.00/- are invented.
Educational material. Not advice on any investment, tax, budget or market position.