Structured Products - Too Good to be True?
IFAs that have presented structured products (be they investment or deposit based) for consideration within their client’s portfolio are more than likely to have experienced that look which says “where’s the catch?”
Structured products can leave some investors overawed, but it is important to remember that these products are designed around the balance of risk and reward. Simple structured products can provide capital protection at maturity whilst offering a bigger return than offered on the high street. However, they are fundamentally tied to the performance of an underlying asset, as well as a counterparty, and this is where the client’s risk profile needs to be understood, and the product conditions clearly explained upfront.
It is key to understand the counterparty risk element. Counterparty credit ratings are freely available and investors need to know that their increased potential upside is, in part, because a counterparty is rated BBB as opposed to a more modest return from one rated AA. The higher reward potential is balanced against the increased risk of a less secure financial organisation.
It is true that a ”kick-out” plan could mature early after just 12 months with a double digit return plus the initial investment in full should the product conditions be met. In these situations, it is easy to see why people think structured products might be too good to be true.
To present a balanced argument it should be noted that there are downsides and these need to be highlightedand fully appreciated before any form of investment can take place. Plans offering the highest rewards, such as the previous example, often put Initial Capital at risk should the underlying asset perform badly and breach any of the downside conditions. Not only would no return be generated but money could be lost. Plans that put capital at risk are likely to have more attractive headline returns than those that don’t – so it is up to an adviser to recommend only plans that fall into their clients given risk profile and capacity for loss.
Structured products are being increasingly viewed as core holdings within investor’s portfolios for their ability to control risk, making them particularly compelling for more conservative investors or when market conditions are more volatile. When comparing an investment in a structured product where the underlying asset is the FTSE 100 Index with a direct investment into the Index itself, one of the first positive aspects to note would be the superior protection that can be provided at the end of a fixed term. A structured deposit, for example, would be 100% capital protected at maturity (subject to the company’s continued solvency) whereas in a direct investment in to the FTSE 100 there is potentially unlimited downside.
Taking this comparison a step further, a structured deposit could provide greater geared participation than a direct investment into the FTSE 100 – theCater Allen Enhanced Growth Plan 9for example provides 5 times the potential growth of the FTSE 100 at maturity, subject to a cap and averaging over the final year of the plan.
It should be noted, however, that investors in structured products linked to equity indices do not benefit from dividend payments. Whilst not receiving dividends, as you would if investing through an equity fund, for example, structured products are unique in that all commissions / fees are incorporated into the product itself. This means that 100% of the client’s money is invested into the plan and no upfront or annual charges are paid during the fixed term as the returns have already taken these into account.
Many structured products look attractive – but as with any investment it is all about analysing the returns available against the potential risk as the value of investments may fall as well as rise. Most providers go to great lengths to make this easy for IFAs. Returns are broken down and shown as potential AERs to aid easy comparison regardless of the payoff profile. Our structured product payout AER comparison calculator available on www.caterallen.co.uk is designed to provide IFAs with a useful resource to analyse and understand the different options available. An IFA that has all the facts about a structured product can easily demonstrate to their clients that these are great investment vehicles offering an appealing balance of risk and reward.
Fernando Gasca, PhD
Head of Investments