In 2010 £12.32bn was invested in Structured Products, which, for the right reasons, remained a popular choice with many advisers; but they’re not all good and IFAs are reportedly only involved in around 25% of the retail market.
Ian Lowes, the Managing Director of Lowes Financial Management, one of the UK’s longest established IFA practices and creators of StructuredProductReview.com, explains why he believes good advisers and wise investors should consider them as part of a diversified portfolio.
Structured Products take many guises and as with any investment solution, a good adviser, or an investor with access to the requisite information, should be able to sort the wheat from the chaff. Whilst they come in a variety of shapes and sizes, structured products usually have the following features:
• Income or Growth, not usually both
• Defined returns and defined risks
• Linked to a defined measurement such as the FTSE 100
• A defined term, typically of up to 6 years
All such investments are designed to be held until their ultimate maturity date and are dependant upon the issuing institution or counterparty being able to repay the proceeds at maturity. Whilst there are many counterparties, a significant number of these investments are backed by the likes of HSBC, Barclays, RBS, Lloyds and the less well known but almost indisputably stronger Dutch bank, Rabobank.
Essentially, structured products fall into three categories:
• Structured Deposits
These are typically sold by banks and building societies, are designed to return at least the original capital in full at maturity and potentially benefit from the Financial Services Compensation Scheme (FSCS) protection of up to £85,000 in the event that the issuer goes bust.
• Capital ‘Protected’ Structured Products
Like Structured deposits, these plans are designed to return the original capital regardless of the how badly the stockmarket or underlying measure performs but unlike deposits, they will not benefit from FSCS protection if the counterparty defaults.
• Capital at Risk Structured Products
These investments will give rise to a loss at maturity if the underlying index performs poorly over the investment term but they typically incorporate a ‘barrier’ which protects the capital other than in the event that the stockmarket falls by, say, 50%. Conversely, by putting the capital at risk these products usually have the potential to produce much higher returns than capital protected or deposit based plans.
As Chartered Financial Planners we often utilize the capital at risk variety alongside a portfolio of funds to potentially enhance or protect the overall returns of the portfolio in both rising and falling market conditions. Whilst less common, we may also use capital protected and deposit based plans to lower the risk of the portfolio.
But they’re not all good! When these plans became popular in the early part of the last decade some were so dreadful and risky that we felt we had to warn our clients away from them. As it happened, this particular breed gave rise to horrendous, unforeseen losses for those who didn’t understand the investment risk. Such contracts have now, effectively, been outlawed.
Other structures that seem like a much safer option have typically been promoted by bank and building society branches to some customers as an alternative to deposit accounts, but these have often also been very disappointing, producing low returns. This is of course, in part, a function of the lower the potential risk, the lower the potential return, but it could also be a result of the profit margin of the distributor being too high. Occasionally, however, there is a good one so don’t dismiss structured deposits out of hand.
Capital at risk
Capital at risk and ‘protected’ products are, like most investments, only suitable for those who are prepared to expose their capital to a degree of risk and accept the consequences of the risks resulting in the worst outcome. Such investments are now numerous and because they are promoted through Independent Financial Advisors they have to be more competitive. The risks and returns for these investments are very definable and, as such, often represent a good complement to an investment portfolio.
For example, if, in 2004 you had invested in one of our preferred, six-year capital at risk structured products alongside the average cautious managed unit trust, the unit trust would have been exposed to the movements of the stockmarket over the period and produced a gain of approximately 30% including reinvested dividends. The terms of the structured product provided for a return of 3.5 times any rise in the FTSE 100 index subject to a maximum return of 63%, having protected the original capital from all but the default of Barclays Bank or the FTSE falling below 2210 points (last seen in February 1991).
Now, a good adviser is unlikely to have constructed such a simple portfolio and so instead of a single cautious managed fund, they may have used a portfolio of funds alongside a few different structures, but I’m sure you get the point.
Of course, in an ideal world we would have consistent markets and managed funds would provide the perfect solution for most investors, but markets are anything but consistent and fund performance depends upon the manager’s ability to time the markets and select appropriate investments and as we know, sometimes, even the best ideas aren’t good enough.
Whilst capital at risk and ‘protected’ structured products have similar initial charges and initial commission / adviser fees as unit trusts and open ended investment companies (OEICS), the fees in the structured products are taken into account in the defined terms. So, for example, an investment of £10,000 in a capital ‘protected’ product will provide for adviser remuneration and in even the most adverse stockmarket conditions, return a minimum of the original investment at the maturity date of £10,000. Of course the caveat is that should the counterparty underwriting the product go bust the investor will get nothing and so the investor or adviser has to consider and accept this risk.
For the portfolio
Unlike most managed funds however, structured products do not provide ongoing trail commission and so some advisers may levy annual portfolio fees.
Investment times are changing and the evolution of the structured product as a mainstream retail investment solution is testament to this. As I hope I have outlined above, they’re not all the same but the best can be very good additions to a diversified portfolio. If you think all structured products are the same and you don't give them due consideration, you won't know what your clients are missing. With this in mind, take a look at StructuredProductReview.com where you can see what the market has to offer and make up your own mind.
Ian H Lowes
Lowes Financial Management
NOTE: This material is intended for financial services professionals only and should not be construed as advice or a recommendation to invest.
StructuredProductReview.com is a free, independent service designed by IFAs for IFAs. It aims to make information on the sector easily accessible to all IFAs, displaying, among other things, information on most of the current products promoted through IFAs, an archive of matured products, including maturity data and an extensive catalogue of educational material. StructuredProductReview.com allows users to survey the market and compare plans, helping them to find the products that best match their clients’ requirements.Visit StructuredProductReview.com here.
Tags: Financial Services Compensation Scheme , FSCS , FTSE , Ian Lowes , IFA , IFA practices , IFA practises , investment risk , Lowes Financial Management , OEICS , open ended investment companies , structured product review , structured products , structuredproductreview.com