Last week's news that structured product provider, Keydata Investment Services had been placed into administration, sent out a few shockwaves - and not only to the 80,000-plus investors who had put their money into the company's plans. Structured products appeal to investors at times of uncertainty - offering participation in the upside if markets take off, and protection from the downside if they bomb. There have been a plethora of new product launches and sales have surged, with investors, independent financial advisers (IFAs) and even fund managers seeking them out.
While there are still some serious questions around the transparency, and security of these products, some believe there is an argument to be made for the role of structured products in delivering efficient, risk-adjusted returns. So should you be considering structured products?
A tainted history
Sold by both high street banks and investment firms, structured products are essentially pre-packaged investment plans which deal in derivatives. They offer investors a predetermined return profile based on specific circumstances related to an index or underlying assets.
As promise of a market turnaround beckons, a gush of new products are being launched in the structured product space, and nervous investors are climbing in. Others, however, remain sceptic, given these investment vehicles' tainted past.
"In the early noughties, structured products failed because the markets fell way beyond expectations. Big name brokers who sold masses of these products - then called 'precipice bonds' - went out of business as the compensation claims mounted," says Danny Cox, chartered financial planner at Hargreaves Lansdown.
But you don't have to go that far back to witness how structured products have let down investors . In 2008 the beleaguered Lehman Brothers was the counterparty backing a number of structured products issued by companies such as NDF, Meteor, DRL, Arc and L&G.
While the Financial Services Compensation Scheme (FSCS) will step in when investors lose money as a result of the investment firm going bust (the limit for investment claims being £48,000, rather than £50,000 for bank savings), this does not apply to the counterparty. So if the plan manager of a structured product, like Keydata, goes into administration, the FSCS could step in. However, if it's the counterparty backing the plan that goes bust, things become more murky.
Bottom line? Investors who put money into structured products backed by Lehman Brothers are still in limbo, and may not receive their capital back.
While the collapse of Lehman Brothers has brought the issue of counterparty risk to the fore, the Investment Management Association (IMA), which represents the UK fund managment industry, has for some time been at loggerheads with structured product providers over the transparency of their plans, saying that the disclosure requirements for products which compete in the same market as funds needs to be similar.
Richard Saunders, chief executive of the IMA, believes that while the last few years have born witness to notable volatility in the stock market, risk is still capable of being managed through diversification, both over asset classes and over time. "Funds are not perfect. But they can be used to manage risk, and at least they are transparent - what you see is what you get. In turbulent times that remains worth holding onto."
Earlier this year, Mr Saunders welcomed a Financial Services Authority consultation paper proposing a new framework to regulate the way that banks treat their customers, but raised concerns that the draft rules do not consider more complex products such as structured products, of which the banks are major providers.
"These products are marketed as equivalent to investment funds - hence there should be a level playing field both from a consumer protection and a competition viewpoint," says Mr Saunders. "What's more, these products are actively marketed by banks as offering many of the benefits of investment products but with limited down-sides. But in terms of security, they are no more secure than any other bank deposit, and some being marketed by major retail banks in the UK are in fact deposited with their offshore subsidiaries."
