Investors looking for a lower-risk source of regular income or to take some of the risk out of a growth portfolio might be tempted by structured products. These can take some of the equity risk off the table, but have the potential for much higher returns than cash deposits. And, according to Lowes Financial Management, an independent advice firm that specialises in advising investors on structured products, the structured product industry has posted some great returns over the past four years.
Let's take a closer look at the findings.
Structured products are designed to give decent returns in flat or rising markets, by offering set returns to investors as long as a particular index does not fall beyond a certain limit over the term. Many structured products have been linked to the performance of the FTSE 100 Index and the soaring markets of the past four years have led to some decent returns.
Research by CompareStructuredProducts.com, an educational website founded by Lowes, found that structured products distributed through the independent financial adviser (IFA) market that matured in the third quarter of 2014 returned an average annualised gain of 7.6 per cent, over an average term of four years. This is an attractive figure, which many investors would be happy with.
However, if you had actually invested in a FTSE 100 tracker fund you may have done better than this. Over the three years to the end of September 2014, the FTSE 100 index returned 44.2 per cent, equating to a compound annual return of 13 per cent, and over a five-year period it returned 54.1 per cent, equating to a compound annual return of 9 per cent.
The difference in return may in part be explained by the fact that most structured product providers take the twice-yearly dividend cheque from FTSE 100 companies out of the equation as they buy index options rather than shares to give equity-linked returns. In addition, they offer some security over your capital. Structured products tend to protect capital in full unless there is a more than 50 per cent fall in the stock market.
Ian Lowes is managing director of Lowes Financial Management. He says: "The FTSE 100 results are very impressive, which reflects the strong performance in our home index, but it should also be appreciated that these results have been achieved while protecting investors' capital from all but the most extreme events."
The best-performing structured product was a FTSE-linked investment, the Barclays 5-year Super Tracker - Dual Option (May 2009 Edition) - UK Option. This offered investors a growth payment at maturity equivalent to four times any rise in the FTSE 100 index, subject to a maximum return of 100 per cent of the investor's original capital investment. It reached this limit, returning 100 per cent over a term of five years. This equated to an average annualised return of 14.86 per cent - and presumably some very satisfied investors.
The worst performing product was a plan linked to commodities, called the Meteor Galaxy Protected Commodities Plan 6 - Super Growth Option. This offered the potential for growth at maturity equivalent to 200 per cent of any gain in a basket of eight commodities, uncapped. However, on maturity the six-year plan returned just 84.44 per cent of investors' original capital - a loss of 15.56 per cent.
This was the only structured product maturing in Q3 2014 that lost investors money, but the risks of structured products need to be closely examined. Here are some key questions to ask.
■ Are you buying at the right time? The higher the starting index level for a structured product, the more likely it will fall.
■ Who is the counterparty? Some structured products are protected by the Financial Services Compensation Scheme in the event of a default by the counterparty and some are not. Credit risk is the main worry for holders of structured products as in the event of a bank failure they could be exposed to catastrophic loss. However, some products are exposed to a range of financial institutions, rather than just one.
■ How is the product structured? This is often complicated and the product explanations are lengthy. Always consider the maximum and minimum outcome from a structured product.
■ What is the charge? Investors often won't see any explicit charges as the costs are wrapped up in the product. But it is worth asking what commission is built into the product for the adviser.
Two structured products to consider:
Below are two structured products that are open to investment and we think look attractive. Both are available for individual savings account (Isa) subscriptions. However, you will need to use an independent financial adviser in order to take them out.
For income seekers: Morgan Stanley Income Accumulator Plan 5
This product offers potential for a maximum quarterly income of 1.685 per cent gross, equivalent to 6.75 per cent a year, of the net investment. It will pay this provided the FTSE 100 Index closes between 5000 and 8000 points on each weekly observation date of the investment term (every Wednesday). Initial capital investment will be repaid in full as long as the closing level of the FTSE 100 Index on the plan end date is at or above 4000 index points.
■ Counterparty risk: The plan is invested in a type of corporate bond issued by Morgan Stanley B.V. and guaranteed by Morgan Stanley, which has a Standard & Poor's credit rating of A-.
■ Financial Services Compensation Scheme: Not covered
■ Best case scenario: 6.75 per cent income a year and full return of capital after six years.
■ Worst case scenario: Capital is lost in line with falls in FTSE 100 Index below 4000 and/or Morgan Stanley goes bust and you get nothing.
For high growth in flat markets: Investec Dual Index Enhanced Kick-Out Plan 11 - Investec Option
This product offers potential for a 12 per cent gain on the net investment for each year held. It will pay this at the end of years one, two, three, four, five or six, if at the end of the year the FTSE 100 and S&P 500 indices have closed above their initial level. If a payout is triggered, the plan matures and your initial investment is returned, together with the 12 per cent per year. However, if either the FTSE 100 or S&P 500 falls by more than 50 per cent at any point during the plan, and either index finishes at the end of year six lower than its starting level, you will lose some or all of your initial investment.
■ Counterparty risk: Investec Bank has a credit rating of BBB- from Firth and Baa3 with Moody's. For investors who are not comfortable with this risk, there is a lower-risk version of this plan which offers five UK financial institutions as counterparties, but the returns will be limited to 10 per cent a year.
■ Financial Services Compensation Scheme: not covered.
■ Best case scenario: Capital uplift of 72 per cent delivered at end of six-year term, plus full return of capital.
■ Worst case scenario: Initial investment is reduced in line with worst performing index as it stands at the end of year six or Investec goes bust and you get nothing.
