Structured investments are often seen as being niche products – or expensive and risky. But could adding structure to your investments be worthwhile?
Last week, the Financial Services Authority announced it was investigating the products – after thousands of people lost out on supposedly guaranteed products that turned out to be backed by Lehman Brothers.
Daniel Barnes looks are the world of structured investment products and sees what is on offer.
What are they?
Structured investment products tend to track the performance of a financial asset through derivatives or other instruments – it is this lack of clarity of how they work that put many people off.
Products can track just the FTSE 100, other indices, foreign exchanges, the prices of certain commodities or even particular sectors. More complex structured products, meanwhile, can offer reverse trackers – going up as an index drops.
A popular product among consumers has been those structured products that offer guarantees to initial capital – the promise being that while returns may not be well up there – at least the money invested will not disappear.
Chartered financial planner Sharon Bratley at FairInvestment.co.uk says: “Most structured products, although not all, do offer some form of capital protection, though in many instances this will be dependent upon the performance of a stock market index.
“The capital protection element of most structured products is part of their attraction, as is the fact that the choice of structured products out there normally means there is something to suit most investors’ attitude to risk.”
She adds they can be used in conjunction with ISAs and SIPPs.
Colin Dickie, a director at Barclays Wealth, explains structured products are not an asset class – they are a form of delivery for asset classes.
“They offer alternatives to both cash and equity investors and can track the performance of any asset class,” he says.
“The exposure can be tailored specifically, and with the benefit of capital protection. That, to my mind, is not a niche product.”
Who is looking for structure?
Structured products are not for those looking for guaranteed returns on an investment, or if they need instant access to funds.
Regular payment options are also not usually offered.
Adrian Lowcock, senior investment adviser at BestInvest, sees the two extreme of investors interested in structured investment products – those looking for risk and those not.
“There are the customers looking for capital protection – especially those who have seen investments fall lately.
“And less common now are those looking for geared and advance exposure.”
Mr Dickie explains one drawback is investors must hold their plans until maturity in order to receive benefits such as capital protection and geared returns.
“However, many providers now offer monthly or semi-monthly liquidity to enable investors to exit their plans much earlier if they wish to do so.”
He adds that the criticism against structured products that tie people’s money in for too long is not so fair.
“Critics often cite the above hold-to-maturity requirement as a reason not to invest in structured products,” he says.
“Interestingly most fund groups and advisers urge investors to hold their funds for three or five years – the typical shelf life of most structured products.”
But Mr Lowcock explains while most investors do have longer term investment horizons, once funds are locked in they cannot be removed – whereas those investing in a funds can move if a fund manager moves or they wish to move sectors.
How safe are they?
The collapse of Lehman Brothers highlighted one class of structured investment investors who were left with nothing.
More than 6,000 people invested more than £200 million of their savings in structured products backed by Lehman Brothers, although did not know the US bank was behind their investments.
While they were assured their initial capital was safe – the small print hid the fact if the backer went under they would lose all their cash.
This is exactly what happened.
Investors are now in the process of complaining to those who sold them the investments and the Financial Ombudsman Service (FOS) – but for some compensation may have to wait until a hearing of a Dutch court.
Headlines surrounding the case have made many investors cautious about moving towards structured products.
Mr Lowcock explains the Lehman case and who is exactly the counterparty to a structured investment has added uncertainty to both investors and financial advisors.
“Financial advisors are concerned, as if they do not know who the counterparty is, then they cannot recommend the product,” he says.
“Structured products are more complex investments and quite a number of IFAs are steering clear of products as they do not fully understand them.”
However, Mr Dickie claims counterparty disclosure, while a problem in the past, is no longer an issue.
“Most providers now identify the counterparty – indeed, there is an argument to say adviser pressure has successfully pre-empted the FSA on this matter.”
“Like all investment products, there are a number of pros and cons to structured products, all of which need to be weighed up,” says Ms Bratley.
“Most structured investment products have a fixed term, so are not ideal for people who may want instant access to their cash at any time, but on the other hand, a fixed term allows for budgeting and planning.”
“As with all investment products, it is important to remember that there will some element of risk involved, depending on the product chosen, and that returns are not guaranteed.”
“Each product is different and has a different strategy. And they are not as transparent as other investments,” Mr Lowcock says.
He explains with that complexity can lead to misunderstanding as advisers might not understand the needs of the customers, and a customer buying off the shelf may end up with the wrong product.
A further drawback is the lack of dividends – as investors are not putting money directly into companies.
“If you are tracking certain companies, the investment company gets the dividends. Dividends are a big incentive.”
However, Mr Dickie questions if this matters in the current market.
“Dividends are being cut or not paid at all. They are also taxed, so investors are getting less than they think,” he says.
He explains structures also often offer investors the chance to use their capital gains tax exemption.
“Most of our products which have matured in the last six months have outperformed tracker funds – reinvested dividends included. Dividends have simply failed to offset market losses. Averaging has also been extremely helpful to structures in the falling market.”
Twitter: My Finances
Join the conversation at #news_myfinances