It is impossible to discuss structured products without reference to their turbulent past. Merchant Capital is the latest in a fairly lengthy line of imperilled structured products providers, with many, including most of the high street banks, having exited the sector completely. What's left is a rump. But, in the Darwinian way of the financial services sector, it is a far healthier rump, with more stable providers and lower-risk products, many of which have matured this year with good results for investors.
In many respects, the products themselves look the same as before. They are based on the performance of an index and will provide a set return if the index reaches a certain point. Capital may be fully protected, or may be at risk if the index falls below a certain point. With the exit of many of the smaller players, the industry is now dominated by the big-name global banks including Investec, Morgan Stanley and RBS.
That said, there have been several important changes to the sector: the first is that it has moved from being directly sold by, say, banks or through off-the-page advertising to a largely advised sale; the second is that the products have become simpler, tending to be based on just one or two indices rather than some of the complex products based on multiple indices or stocks that used to be commonplace. Equally, providers are now required by the Financial Services Authority to give clear guidelines on the potential risks and rewards of each product.
Nev Goodley, vice president at Morgan Stanley Structured Products, says: "The market has changed. The majority of providers only take advised business now. Morgan Stanley has some execution only business, but it still has to be assessed for suitability and the majority of providers work in the same way. There are fewer providers than there were. Equally, the majority of our products are single index, based on the FTSE 100, Eurostoxx or S&P 500."
You can search for an independent financial adviser in your local area using the Find an IFA tool at http://www.investorschronicle.co.uk/2011/09/21/your-money/tools-and-calculators
However, not all IFAs are fans of structured products.
An IFA that specialises in structured products is Lowes Financial Management.
Telephone: 0191 2818811
They also provider an excellent educational website: http://www.comparestructuredproducts.com
Suzi Hampson, an analyst at Future Value Consultants, which provides research on structured products to investment advisers, says there have been some more esoteric launches in recent months as the appetite for risk has grown among investors, but in general the Morgan Stanley approach reflects the wider market: "There are a few products based on proprietary indices, but FTSE 100 products dominate."
This improved simplicity is a welcome development. Structured products usually require an index to perform in a certain way to deliver their goals and the fewer moving parts, the more likely this is to happen. Mr Goodley says: "If a structured product is based on the FTSE 100 and the S&P 500, two indices have to be up. It is the same with a basket of stocks, and the past few years have shown that even blue chips such as BP or Tesco can have bad years."
The pricing is still undoubtedly opaque. Ms Hampson says: "It is quite difficult to compare two different products on charges; the products can have a lot of moving parts and the fees may not be immediately reflected in the terms of each product. We issue a 'value for money' score for all products we rate, which aims to take this into account."
But pricing has also changed, this time in connection with the Retail Distribution Review. Previously, structured products incorporated commission into their charging structures, but many products are now put together without this in-built commission, and that is reflected in the terms of the product - there might be a higher income, or higher capital return. For investors, it is a case of looking at the terms and deciding whether they look reasonable.
With 'precipice bonds' and other high-risk products now out of the market, the biggest risk for most products is now counterparty risk. No one would have considered this a risk of any magnitude prior to 2008, but Lehmans' bankruptcy made it a reality. Banks are undoubtedly in better shape. However, it is worth bearing in mind that some structured products are protected by the Financial Services Compensation Scheme and some are not. In general, those labelled 'deposits' qualify, and those labelled 'plans' do not. Deposits are liable for income tax, while plans are taxed as capital gains.
Darius McDermott, managing director of Chelsea Financial Services, says: "The main risk with structured products is that the counterparty goes bust. This risk was high post-Lehmans but has lessened in the subsequent years post the eurozone's Long-Term Refinancing Operation.
In spite of these limitations, investors like the predictability of structured products. The risk/reward profile is easily understood and there is a defined return. Some products offer full capital protection. Goodley says that Morgan Stanley's capital protected plan remains one of its top-sellers. Non-capital protected structured products still run the risk that if a certain market level is breached, investors will lose some of their capital, but it should be clear when that risk kicks in from the product terms. Structured products also allow investors to access higher risk areas such as commodities or emerging markets with some downside protection.
Gary Dale, head of intermediary sales at Investec Structured Products, says: "Structured products are designed to give competitive returns in flat markets. The market does not have to deliver 40 per cent for a structured product to deliver 40 per cent. With traditional investment funds it is difficult for investors to predict with any degree of certainty what they will get back. With structured products, they know what they are getting."
Nevertheless, some advisers still believe there is better value elsewhere. Danny Cox, head of advice at Hargreaves Lansdown, says: "Those structured products maturing in 2012 should have hit their pricing points as markets were up over three, five and six years. The structured product industry has taken some steps in recent years to improve its literature and descriptions of how these products work. However, they will always lack transparency and the costs will be unknown. The cost to the investor includes foregoing dividends (around 3 per cent based on the FTSE 100 alone) and the rise on the market above the product's nominated pricing point."
The structured products industry has pulled itself into shape over the past five years. Some investors will be put off by the dominance of banks and the opacity of pricing, but others will welcome the predictability a structured product can provide.
These are four popular structured products plans - each offering investors something a little different:
FOR THE NATURALLY CAUTIOUS
FTSE Protected Growth Plan 51
This capital protected plan from Morgan Stanley is about to launch its 52nd incarnation and has been a structured product perennial since 2003. It offers investment growth linked to the FTSE 100: if after three years the FTSE 100 has risen 5 per cent or more, a kick out feature is triggered and the investor receives 20 per cent growth plus their initial investment. If the kick-out is not triggered, investors receive 100 per cent of the growth in the FTSE 100 over six years. If the FTSE 100 falls or stays the same, investors receive no growth, but get their money back. The capital is guaranteed by Morgan Stanley, so investors are still exposed to the risk that Morgan Stanley will go bust.
Future Value Consultants (FVC) Value for Money Score: Score: 9.39/10
R 2068 RBS Markets Atlantic 14.5 per cent Autocall
This is one of the few structured products exposed to more than one index, though admittedly nothing more complex than the FTSE 100 and the S&P 500. It offers a potential return of 14.5 per cent per year (not compounded). In common with many products on the market at the moment, the product 'kicks out' if on any of the product's anniversaries both indices are at or above a certain level. Capital is not protected at maturity if the final values of one or both of the indices are below 60 per cent of their initial value. The double index structure introduces more risk because both indices have to hit a certain level and not fall below a certain level, but the potential return may lure investors in the current market.
Contact: email@example.com, telephone: 0800 121 6286
FVC Value for Money Score: 9.62/10
FOR LONGER-TERM INCOME
R 2636 Investec Structured Products FTSE 100 Target Income Deposit Plan 1
This is a six-year capital protected deposit product linked to the FTSE 100 index. It pays potential annual interest of 4.5 per cent, provided the closing level of the index stays above 90 per cent of its initial level on every anniversary. If the closing level of the FTSE 100 is below that, the product pays no interest that year. However, even if the index has fallen at the end of the term, the investor gets their money back at maturity, subject to Investec remaining solvent. Returns are subject to income tax.
Contact: www.investecstructuredproducts.com, telephone: 020 75974065
FVC Value for Money Score: 9.57/10
FOR REGULAR INCOME
R 2619 RBS UK Fixed Income Plan
This is a six-year capital at risk income product linked to the performance of the FTSE 100, which pays a regular income. The products pays out 1.25 per cent (5 per cent gross each year) quarterly over the term, regardless of the performance of the index. An investor's initial capital is at risk if the index falls by more than 50 per cent during the product term. FVC calculates that the probability of hitting the barrier and losing capital is 2.7 per cent.
Contact: firstname.lastname@example.org, telephone: 0800 121 6286
FVC Value for Money Score: 8.62/10