Structured products: Scare-mongering or safe bet? Only you can decide
They promise growth and protection, but are so complex all but the most hardened investors should take care
Sunday 21 October 2012
On the surface, structured products seem to have it all. These investments not only claim to deliver an attractively high level of growth or income, but they even offer protection so you will be cushioned from a blow if markets fall.
At a time when interest rates are at rock bottom and government bonds are yielding a measly 1.8 per cent, a structured product that professes to give income of 8 per cent a year, or two times the growth of the FTSE 100, for example, while offering to protect your capital, sounds like an offer you can't refuse.
But, sadly, as that old adage goes, if it seems too good to be true, it probably is. And it's not even that long ago that the collapse of Lehman Brothers undermined the label "capital guaranteed" and saw a raft of investors join the creditor queue to claw back some of their investment.
If you're wondering at this point "what is a structured product?", then trying to understand the varying definitions is almost an accomplishment in itself. "We are sceptical of structured products, says Rob Morgan at Hargreaves Lansdown. "If a product cannot easily be explained then we are on our guard."
These products have a set investment term, requiring you to invest in them for six years, for example. They are linked to a stock market index, like the FTSE 100, or a number of shares, and generally offer income or growth.
However, as the products should state, your investment is not guaranteed and you could find that if the stock market goes down more than expected, or if the provider of the product fails, you lose some or, potentially, all of your money.
"I loathe and detest most structured products," says Philippa Gee, of Philippa Gee Wealth Management. "All too often they fail to deliver and tend to be "sold" to those investors who are scared of the markets."
You are either so worried about losing your money that equities are not right for you, says Ms Gee, or you build a properly diversified portfolio that will provide the spread of investments you need. "To play on investors' fear is nothing short of scare-mongering," she adds.
Castle Trust only recently came to market with a set of innovative property investments with the backing of some major names in the financial world, claiming to outperform UK residential house prices – whether they rise or fall – and give you a regular income.
Although these aren't technically structured products, you would be forgiven for thinking so, and if you lift up the bonnet of these investments, they will likely leave you flummoxed. As the products warn – if you don't understand them, it's probably best not to invest in them.
"The HouSA literature rightly says you should not invest if 'you are not sure how a HouSA works," says Jason Hollands at Bestinvest. "Anyone thinking of investing in this should definitely plough through the 71-page prospectus document to try and understand the structure and workings of the products."
It's not just the products, though, that can be deceptively attractive. It may also look like there are no charges attached to them, or that there are very low costs involved. "This is not the case, but all too often the charges are not explicitly shown and instead are hidden in the product," says Ms Gee. "So the investor believes that the company is operating the investments on a saint-like basis, taking no charge – but usually it is quite the opposite."
The typical initial commission on a structured product is 3 per cent, which is broadly similar to those of actively managed funds. "The big difference is that commission payments and other charges in a structured product are hidden away," says Patrick Connolly, of AWD Chase de Vere.
"This means that if somebody invests, say, £10,000, on day one their investment is still worth £10,000 and they also don't see any ongoing charges," adds Mr Connolly. "This means that higher commissions aren't easily noticed by investors and also with no explicit charges, this makes the products much easier to sell."
And big sellers of structured products, like banks and building societies, will earn bigger commissions, perhaps 4 or 5 per cent, giving them greater incentive to sell them. "While not visible to investors, I have seen examples of initial deductions of up to 10 per cent on structured products in the past," says Mr Connolly.
But it would be unfair to tar all products with the same brush. If you understand them and realise the risks you are taking, the rewards may play a useful part of your over-all investment portfolio. "The level of the index at the time you buy a structured product is the important bit," says Darius McDermott, the managing director at Chelsea Financial Services.
"A structured product we like at the moment is the Gilliat Income Builder Plus which is offering 8 per cent income each year as long as the FTSE doesn't go below 3,500," says Mr McDermott. "With the FTSE where it is today, we think this is a reasonable risk to take."
One of the main risks you should be aware of, adds Mr McDermott, is that the counterparty – the bank underwriting the product – goes bust. In 2008, this is exactly what happened with the failure of Lehman Brothers, hitting many structured products investors hard.
"Also, if the market level is breached investors will lose some of their capital – possibly a significant part – which is why the starting level is so important," says Mr McDermott. "It's also worth remembering that most do not pay dividends which make up a substantial part of total returns over time."
You should also bear in mind that once you hand your money over, it is locked up for the product's term, which could be six years. Although you can draw your cash out before the six years is up, you will pay a price for doing so, so it is best to invest money that you won't need to access.
As with any investment, there are risks. If you can manage to understand structured products, remember these glittering returns or headline growth rates come at a price, which may be lurking beneath the surface.
Emma Dunkley is a reporter for citywire.co.uk
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