With fears that the stock market is peaking and with low interest rates on offer elsewhere, some investors are looking to structured products for their next opportunity. Returns average more than 5% a year, yet the number of people investing in this way remains low, with critics arguing they are risky and too complex for most people to understand. We find out if structured products are a rewarding way to invest your cash.
Structured products are fixed-term investment instruments that track a stock market index, such as the FTSE 100 or a ‘basket’ of companies. The more the value of these underlying investments rises over the fixed period – typically between three and six years – the bigger returns investors receive.
There are two types of structured product on the market – capital-at-risk and deposit-based accounts. With deposit-based accounts – also known as structured deposits – your money is protected and you will never make a loss, even if the value of the underlying stock market index falls.
Capital-at-risk accounts – sometimes called structured investments – offer higher returns. However, you risk losing your cash if the underlying stock market index fails to perform. This is a similar type of risk to buying shares in a company.
A controversial past
The complex nature of structured products can be offputting for novice investors, especially those used to more basic investing in savings bonds or tracker funds.
They have been the subject of mis-selling scandals in the past, and some say they still represent bad value for consumers. Regulator the Financial Conduct Authority (FCA) warned in 2016 that most people find it “difficult to understand” how structured products actually work in practice. The FCA says this resulted in consumers overestimating the potential returns.
Alan Steel, chairman of independent advice firm Alan Steel Asset Management, says: “Have you heard about 10ft bargepoles? That’s what we think of structured products – we wouldn’t touch them with one.
“In a rising market, they’re poor value – thanks to all the profit margins built in – and they can be dangerous when markets fall.”
But Graham Devile, managing director of structured product provider Meteor Asset Management, argues that these products are often misunderstood.
“I don’t think they’re too complicated. Most of what’s on the market today is relatively ‘vanilla’,” he says. “It’s no different to funds, where you can look at a FTSE tracker versus a special situations fund. One is simple; one is complex. Everyone seems to think they’re a replacement for funds, but they’re a supplement. Structured products should be no more than 10% to 20% of a portfolio.”
Understanding the risk
For investors, the returns on offer seem attractive. Research by independent financial advice firm Lowes says capital-at-risk products maturing in 2016 returned 6.62%, based on an average term of 3.82 years, although there was a wide variation in results. The top investments returned 10.4% a year whereas the bottom quarter returned 2.01% a year.
For deposit-based products, the average annualised return was 3.31% over an average term of 5.24 years. The top quarter of investments returned 6.16% a year versus just 0.06% for the worst performing investments.
Across both categories, only nine of the 427 maturing products made a loss in 2016, although this was a year that saw a record performance by the FTSE 100 index – the underlying index for many structured products. There is no guarantee that this type of investment will perform as strongly in future.
Structured products should primarily be considered by investors who have a highly diversified portfolio already. If that applies to you, then the key decision to make is whether to invest into a capital-at-risk or deposit-based product.
Consumers also need to make sure they understand the possible outcomes when choosing their investment. Those using deposit-based accounts are protected by the Financial Services Compensation Scheme (FSCS) up to £85,000 per person per financial institution.
If you choose a capital-at-risk product, you need to be confident that the bank will be able to pay the investment back at the end of the term, as your money isn’t covered by the FSCS.
This issue is called counterparty risk and while bank failures are very rare, they can happen.
Investors must also be prepared to lock their money away for the full investment term. This can be as long as 10 years, but is usually between three and six years. In some instances, you can sell your product before the end of the term, but this will result in exit fees being charged.
Make sure you also consider the ongoing fees and charges from your provider. Even in deposit-based accounts, you could receive back less than your initial investment after you pay these fees.
Mr Devile says average charges are between 1.5% and 2%, meaning that on a long-term product such as a 10-year income trade, this works out at less than 0.2% a year.
But Mr Steel believes these fees are still too high: “Having experienced what can go wrong with them, 20 years ago we decided structured products tended to make money mainly for the designers, not for advisers and especially not for investors.”
Instead of structured products, Mr Steel prefers using long-only fund managers and moving funds based on a client’s attitude to risk at any one time.
“We much prefer investing our client funds in uncomplicated, long-only inexpensive investment funds, protecting the downside with cautious, simple funds such as Trojan fund or CF Miton Cautious Multi Asset fund,” he says.
Whatever your opinion, talking to an independent financial adviser will help you understand whether this is an appropriate investment for your circumstances. Don’t be taken in by the promise of high returns, and always consider how much you are willing to invest and then choose on that basis.
What you could buy
If structured products are for you, Graham Devile of Meteor Asset Management cites the company’s Contingent Income Plan April 2017 as a simple capital-at-risk product, which could appeal to first-time investors.
“This pays 1.5% a quarter and 6% a year,” he says. “It observes the FTSE 100 index and if it’s above 60% of its starting level it pays out 1.5%. You have an income stream and the risk is counterparty risk. That’s vanilla and easy to understand.”
It is available to buy until 26 April 2017 and can be held within an individual savings account (Isa) wrapper. You can either buy direct or through an independent financial adviser.
How structured products have performed
Research by independent financial advice firm Lowes Financial Management shows that almost nine in 10 (89%) of all structured products that matured in 2016 generated a positive return for investors, with only a tiny proportion of products (2.1%) resulting in a loss for investors. The rest returned investors’ capital, but made no gains. The average annualised return was 5.48% over a term of 4.31 years.