Investment guide: structured products
It's not difficult to understand why some rate-starved savers are attracted to structured products. They have long been marketed as providing a middle ground between the potential for investment growth and capital protection.
However, while it's true that some structured products have handsomely rewarded investors (note the use of the word 'investors' here and not 'savers'), these are complicated financial products and should not be entered into lightly. Some are much more complicated than others and mis-selling scandals over the past few years have meant the likes of Lloyds have stopped selling them.
That said, some investors swear by them. To help you decide whether they may be appropriate for you, here's the Moneywise guide to structured products.
What are structured products?
There are three main types: structured deposits; capital protected products and 'capital at risk' products.
1. Structured deposits can be thought of as a mixture of a traditional savings account and an investment, providing a fixed return over a set period – typically anything between three and six years – dependent on the performance of a specific stockmarket benchmark, often the FTSE 100 index.
The main difference with direct investments is that, even if the benchmark performs poorly, you still get all your money back. Should anything go wrong with the companies that provide the products, your money is covered by the Financial Services Compensation Scheme (FSCS) up to £85,000 per person, per institution – just like money in a savings account.
2. Capital protected products aren't a million miles away from structured deposits. They're designed to hopefully make a healthy return but give you back your original deposit should the stockmarket perform poorly. Unlike structured deposits, however, your money is not protected by the FSCS if the investment company were to go bust.
3. The raciest of the three are 'capital at risk' structured products. If the underlying benchmark performs poorly, you will not get back the full deposit you originally invested.
However, most of these products come with a safeguard of sorts that protects the deposit should the benchmark drop beyond a certain level – which is often set at a drop of 50%, compared to its starting level when the investment was sold. In such a situation, investors will lose some capital but not all of it. They will usually lose it on a 1:1 basis so that if the underlying benchmark is down by, say, 55%, then the investor will lose 55% of their capital (£55 for every £100 invested).
Autocall, or 'kick out' plans have become popular among these riskier products, paying out a defined return providing a certain trigger occurs - such as the index moving by a specified amount. Should that happen, the plan comes to an end early and pays back the investor's capital plus a return agreed at the outset.
If it doesn't happen, the plan keeps going on a yearly basis either until the trigger occurs or until the plan reaches maturity. And if it does reach maturity, then the plan pays out the cumulative return as well as the giving back the original capital invested.
What's the performance like?
While past performance is no indication of future performance, some structured products that have matured recently have done so with healthy returns for their investors.
Data from CompareStructuredProducts.com shows that of the nearly 200 structured deposits and capital- protected products that matured in the 12 months to 31 March 2015, the average annualised return for all FTSE-100-only-linked products was 5.76%.
On average, they took just under five years to mature, a time in which the FTSE 100 recorded a 7.3% annual return, according to Morningstar. This means that had the investor put £10,000 of their money directly in the stockmarket rather than the structured product, their investment would have grown by £733 a year compared to £576. And the bottom 25% of products produced returns of just 3.87% a year.
This is a common criticism of structured deposits and capital protected products; they only offer investors a limited amount of the growth of the underlying index their money's invested in. That said, they safeguard an investor's money from the ravages of falling stockmarkets, which, of course, direct investments simply can't do. So the limited upside is in effect the premium the investor must pay to insure their capital.
That said, some structured deposits have paid out high double-digit returns. Ian Lowes from CompareStructuredProducts.com points out that the best-performing structured product that matured in the year to 31 March 2015 was a capital protected plan provided by Morgan Stanley, which matured after six years with an 85.8% gain.
However, Patrick Connolly, a chartered financial planner at Chase de Vere, urges investors not to be blindsided by such high figures and warns of the downsides of structured products.
"In order to provide some degree of protection, most structured products cap returns and/or don't allow investors to benefit from dividend payments."
He adds: "These products often have limited liquidity, meaning investors get hit with big penalties if they want to access their money and charges are hidden so investors don't really know how much they're paying."
This lack of transparency, he says, is a big issue. "These products are often complex with hidden charges and risks and, quite simply, people shouldn't invest in products they don't understand."
There's also an argument to be made that structured products are expensive, especially if sold by advisers who can charge advice fees each time a product 'kicks out' when an index falls or rises too much or when the product reaches maturity.
The FTSE itself is another source of concern about the sale of structured products at the moment. The FTSE 100 has recently been hitting all-time highs and so there's a pretty reasonable chance it will drop back over the time products currently on sale take to mature.
However, Mark Fuller, head of structured products at wealth manager Mattioli Woods, which sells structured products, says: "Trying to second-guess where the next all-time high FTSE 100 will be and when it will occur is an impossible process. There are too many factors influencing the movement of the FTSE to be able to distil the causes of why the market is currently near its all-time high and the effects that will make it go higher or fall back.
"However, structured products can be used to provide an above risk-free return, plus the investor's money back if the FTSE 100 falls, rises or stays the same. I could give many examples but a good current example is the latest Mattioli Woods FTSE Supertracker plan."
With it, the investor buys a six-year investment and receives their money back plus a 2.02% return for every 1% rise in the FTSE from 85% of its level at the close of business on 15 May 2015. At the time of writing, the FTSE was at 7000. "Let's assume the FTSE is still at 7000 on 15 May," says Fuller.
"On 17 May 2021, if the FTSE is above 5950 the customer will receive their money back plus 2.02% of the positive FTSE performance. In other words, even if the FTSE is at 6300 on 17 May 2021, the investor will receive 110.1% of their original investment back. This return will be achieved even though the FTSE is below its level at the start of the plan."
And, of course, there are other indices that structured products can give investors exposure to. As an example, Fuller says: "We paid the investor their money back plus 78.87% on a structured deposit linked to the performance of the S&P500. The deposit ran for five years from November 2008 until November 2013."
Structured products may be suitable for people who can't afford to risk all their cash in the stockmarket, as long as they fully understand from the outset that they will never access the full gains the stockmarket can offer as a result, and the complexities of the product they buy. They should only ever make up a small proportion of a well-diversified investment portfolio.
The practice of a dishonest salesperson misrepresenting or misleading an investor about the characteristics of a product or service. For example, selling a person with no dependants a whole-of-life policy. There have been notable mis-selling scandals in the past, including endowment policies tied to mortgages, employees persuaded to leave final salary pensions in favour of money purchase pensions (which paid large commissions to salespeople) and payment protection insurance. There is no legal definition of mis-selling; rather the Financial Services Authority (FSA) issues clarifying guidelines and hopes companies comply with them.
Structured products offer returns based on the performance of underlying investments. Many products are linked to a stockmarket index such as the FTSE 100 or a “basket” of shares. There are generally two types of product, one offers income, the other growth and investors have to commit their capital for the prescribed term, usually three or five years. The investment is not guaranteed and if the index or basket of shares does not perform as expected over the term the investor might not get back all their capital.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.