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Dispelling myths about Structured Products
Gary Dale, Head of Intermediary Sales at Investec Structured Products explains in detail the characteristics and benefits of a structured product while demystifying an investment that has received considerable bad press over the last few years.
The term "Structured Products" conjures up many pre-conceived notions and ill-conceived ideas of financial products that are sold by both banks and advisers to unsuspecting investors looking to spice up their portfolio.
The media has also used the term to describe toxic bundles of debt - a CDOs or Collateralized Debt Obligations - passed around from one institution to another. And structured products have been hung out to dry particularly after the collapse of Lehmans and the start of the financial crisis, often blamed for the heavy losses suffered by retail investors.
What exactly is a Structured Product?
This is an almost esoteric question, to which it is all but impossible to find a common answer. They can loosely be defined as a savings or investment product where the return is referenced to an underlying asset or index, such as the FTSE100, and delivered at a defined date (the maturity date).
It is a generic term that is often used to describe products with ‘non-traditional’ investment strategies. And of course under this umbrella one can invest in Structured Deposits, Structured Investments and Structured Funds.
The diagram below shows in very simple terms how a Structured Deposit works in practice.
Consider a product that aims to return the initial deposit at maturity plus an interest payment linked to the performance of an underlying asset or index, i.e. the FTSE100 index. For every 100p invested, 85p is used to return the initial deposit at maturity. This is because the provider is able to “lock in” a rate of interest over 5 years sufficient to return the initial deposit. 6p is used to build the product and cover expenses with the remaining 9p being used to buy financial instruments which provide the performance element (interest payment). The performance element could say, if the FTSE100 is higher at maturity then a fixed interest payment of 35% will be made, however if the FTSE100 finishes lower at maturity then only the initial deposit will be returned.
A typical Structured Deposit – 5 year plan linked to the FTSE100 Index
There are fundamental differences between Structured Deposits, Structured Investments and also Structured Funds, not just in how they are designed but also in how they can and should be applied to client’s investment portfolios.
Structured Funds, for example, are still a form of Structured Investment but, provided the term is being used correctly, are completely different in terms of the underlying regulations upon which they are ultimately governed. They are also different in terms of investor accessibility, investment wrapper and, in many cases, the level of capital protection afforded to the investor. Of course, the return profiles on many Structured Funds may look similar to many Structured Investments, for example a ‘kick-out’ is a ‘kick-out’ irrespective of how it is wrapped, however, there are many other benefits to a Structured Fund that should definitely be considered.
A common misconception is the belief that Structured Products are an asset class in their own right. I strongly disagree. Structured Products are not a separate asset class but simply a means of accessing index or asset class returns in a predefined, sometimes more efficient way.
Advisers are able to diversify an investor’s portfolio both at a macro and micro level, i.e. start with the appropriate asset class model on a risk weighted basis and then start to diversify and stock pick within each of these asset classes. And it is true, that most Structured Products also offer some form of capital protection making the pay-off profile more difficult to include in a traditional risk-weighted portfolio. However, surely it is more appropriate for an adviser to adapt his investment approach given the product choice available, as opposed to trying to shoehorn a client into possibly a less efficient portfolio.
Why are Structured Products viewed so negatively?
Unfortunately for these investments, the word 'structured' often has the negative effect of putting many advisers off from even considering their potential benefits and fully understanding both how and what they have been designed to achieve.
Of course, the FCA have established many weaknesses relating to some Structured Products pre - Lehman but many of their findings were centered around the failures within the advice processes themselves, caused primarily by weaknesses around product suitability. However this is arguably true of the majority of mis-selling scandals in the past such as endowment sales, pension transfers and more recently unregulated collective investment schemes (UCIS), which have all involved failings with the suitability requirements and not specifically about the products themselves.
The word 'structured' in this context simply means 'pre-defined', both in terms of upside and downside potential which, in today's hugely unpredictable investment climate, should offer a little more comfort to many investors over and above the more traditional type investments.
Sadly however, over the past few years certain industry commentators and elements of the media have been only too happy to attack these plans as “high risk” or “unsuitable” with some ill-informed individuals calling for a complete ban altogether.
If researched properly however, it is evident that there are appropriate solutions available in the form of Structured Products for investors looking to add that extra appeal to their portfolio. And it goes without saying that suitability cannot be ignored and should be fully considered before ANY product recommendation.
So perhaps the industry should be a little more circumspect when describing these investments?
Who or what is to blame?
Facts tell us that some investors have been scarred by poorly designed, poorly marketed and above all, poorly distributed structured products. One of the key reasons is often related to the unsuitability of the product when compared to the client’s underlying objectives or has been the case in the recent past, lack of clarity on the underlying counterparty exposure.
There are two main distribution channels that deliver structured products to the end customer’s portfolio – the first is a financial adviser, independent or restricted (intermediary), that acts independently of the product provider and advises a client based on their profile, appetite for risk, requirements for income and capital appreciation. The intermediary is obliged by regulation to offer a range of suitable products without displaying loyalties to any one provider. These recommendations may or may not include Structured Products.
The second distribution channel is the tied sales forces employed by the product providers themselves - banks, building societies or other financial institutions. Clients of these institutions will typically be offered these products without any accompanying independent advice and as a result may end up with a product or structure that may not be best suited to their needs, as evidenced by various regulatory censures over the past few years.
From the Structured Product market reaching a peak of £14.4bn of total sales in 2009 it fell last year to around £6.2bn as a direct result of declining bank and building society distribution.
Frankly, I don’t think this is necessarily a bad thing since over the same period intermediary sales of Structured Products have significantly increased and in my mind, with the exception of true execution only transactions, Structured Products should be offered in the main by intermediaries as part of a wider investment portfolio.
Structured Products have also been tainted by recent scandals around poor product design involving “precipice bonds” where many clients lost capital. The furor around the ‘Key Data’ scandal caused, and is still causing an incredible amount of “noise” much of which is fuelled by inaccurate and ill-informed opinion within elements of the media.
The only way to avoid these issues in the future and impress the need for client suitability to remain a priority is for providers to work with the media as well as industry associations such as the Institute of Financial Planning (IFP) and The Personal Finance Society (PFS) to ensure education is at the top of the agenda and that Structured Products are primarily delivered as part of a holistic investment portfolio.
Investec Structured Products offer our range of plans via intermediaries only and we are committed to developing this distribution channel as well as ensuring that customers who demand direct access are supported in the most efficient ways.
Why can Structured Products make a good investment?
The Structured Investment industry is often hailed as one in which retail investors have a more alternative route to market in terms of the underlying asset or index and variety of pay-offs available.
The flexibility afforded by these products means that they literally can be structured to suit not only many different individual risk appetites but also many different investment market cycles.
Our aim, and that of the wider industry, is primarily to encourage more advisers to consider these plans as an integral part of the portfolio planning process and this can be achieved by promoting a better understanding and knowledge of not only the products themselves but also how we believe to best utilise these strategies within a well balanced portfolio, both from a cash perspective and also to complement equity based investments.
The importance of education and the introduction of RDR
Feedback from our consumer panels tells me that consumers are now much more financially literate and possess a greater understanding of the range of financial products available to them and more importantly, how and when to use them.
Combine this with the recent implementation of the Retail Distribution Review (RDR) which removes provider and product bias from the advice process and logic tells me that as well as the obvious benefits in transparency and more holistic advice, consumers are now empowered through greater knowledge and education to better consider a wider choice of investment solutions, especially when working with an independent adviser.
Having said all of that I believe that the key point is this: no single product, fund, asset class, wrapper or pay-off is likely to meet the needs of a diversified investment portfolio in full. Choice is key across all of these areas.
Let’s hope our efforts are not in vain and once and for all, quality structures are accepted as mainstream where the ultimate beneficiaries are, of course our clients.
This article is for general guidance only and should not be relied up as constituting advice suitable to your particular circumstances. You should seek your own independent advice from a suitable professional before taking any action following this article. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested.