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Structured products to buy today

Structured products can protect your capital from market falls but some advisers think the risks are too high

After double-digit returns from equities in 2013, all bets that the FTSE 100 will break through the 7000 barrier seem to have been put on hold, with many investors expecting the traditional fall in the market over the summer. And while structured products can protect against market falls, advisers are divided on whether now is a good time to buy a structured product for your portfolio.

Structured products are investments backed by a counterparty where the returns are defined by reference to an underlying measurement such as the FTSE 100, with returns delivered at a defined date. They aim to provide some protection against market downside and achieve a defined outcome which could be useful for financial planning. Some products are growth orientated, and some focus on income, and with the latter investors hope to get a regular income and defined outcome.

Some structured investments offer the chance for better returns than investing directly in the market. Investors in structured products that matured in April comfortably beat the FTSE 100 index (see table below). They could be used, for example, in drawdown by building a portfolio of products that mature every year so you get an annual payout. They could also be used in this way for school fees.

 

First-quarter 2014 maturities of IFA distributed UK retail structured products

All productsFTSE 100 only linkedNon FTSE only 100 linked
Number of products1168432
Average total gain (%)29.1131.7522.16
Average terms (years)3.973.84.4

Source:CompareStructuredProducts.com

 

Returns on structured products maturing in April

PlanStrike dateStrike levelFinal index dateFinal index levelFTSE gain (%)Plan gain (%)
NDFA Accelerated Growth Plan February 0825/04/086091.425/04/146627.358.885
Keydata Dynamic Growth Plan Plus 625/04/086091.425/04/146685.79.7680
Merchant Capital Kick Out Plan FTSE Issue 716/04/125666.316/04/146584.216.221
Arc Enhanced Growth Plan 26/04/093993.57/04/146622.865.84100

Source: CompareStructuredProducts.com

 

However, structured investments involve downside risk. For example, a product might offer you 65 per cent on the investment if the FTSE 100 is at the same level or higher on the day the product matures in five years' time. If the FTSE 100 is below that level, it will return the investment capital, unless it is more than a specified amount below, say 50 per cent, in which case capital will be reduced by the equivalent fall in the FTSE 100.

For this reason, Jane Heyman, chartered financial planner at McCarthy Taylor, argues that now is not a good time for structured products. She says markets are at particularly high levels so there is the possibility of them going lower. "The market may sit around these levels for a while but it will not do this forever, so if you are locking into a term investment for around five years there is a risk," she says. "I think the downside potential for these investments is too high at the moment."

However, Ian Lowes, managing director of Lowes Financial Management, argues that if you take a medium- to long-term view on your investments it should mitigate against falls in the short term, and if your portfolio is diversified, this also helps. He also points out that some products provide positive returns even if the market goes down. For example, you may only reduce your capital if the index the product is linked to goes down by more than 50 per cent.

The type of barrier a product has is important. If it has an 'American barrier', this means that if the index it is linked to falls, for example, more than 50 per cent during the term of the product your capital will be reduced. But if it has a 'European barrier', then your capital is only reduced if the market it is linked to is down more than 50 per cent on the day the plan matures.

 

Risks of structured products

Even if the market doesn't fall so much that your capital is reduced, but rather preserved, you are still at risk from inflation over a five- or six-year period, although you would be in a better position than with an equity investment.

You get a predefined amount with structured products so if markets do very well your return could lag the market, whereas with a tracker, a fund or an investment trust your upside is not capped.

You face counterparty risk, though. Structured products are typically structured as a loan to a financial institution. If this institution becomes insolvent or for other reasons cannot honour its obligation you may not get your capital back. This happened to a number of structured products that had investment bank Lehman Brothers as the counterparty during the financial crisis.

Structured investments do not benefit from Financial Services Compensation Scheme (FSCS) protection unlike regulated unit trusts and open-ended investment companies (Oeics). If the latters' managers became insolvent you would qualify for up to £50,000 in compensation per company.

Ms Heyman says that when choosing a structured product you should opt for one where the counter party is financially strong. A way to assess the financial strength and likely ability of the counterparty to pay is via its credit rating. Credit ratings range from AAA for the strongest down to D for the weakest.

Mr Lowes suggests you have a range of structured investments that have different counterparties so you are not exposed to just one. This means you can also include some higher paying products without over exposing yourself to risk: products with counterparties with lower credit ratings can give better returns. But investors with a lower risk appetite should stick to lower-risk products.

Because structured investments have a set term if the markets are not doing well you cannot sit on your investments and wait until the market goes back up to sell them, unlike with funds or investment trusts, points out Ms Heyman.

Some structured investments, known as auto call or kick out, mean you could exit the product early. This is where an investment that maybe has a maximum term of five years could end and pay out on specific anniversary dates, for example, one, two or three years after you start the investment. This can happen if the index it references hits a certain level on the anniversary, a common example being if it is equal or above its initial level since the start of the plan. Typically, the payout will be lower than later in the plan so you will not get as much after one year as you would with longer durations.

Unlike holding a share or a fund, structured investments do not pay dividends.

If you sell your structured product before its full term is complete you will not get any of the benefits of the intended outcome but rather just the value of the assets, which will depend on how they have performed. You may also have to pay an administration fee to do this.

Advisers suggest that structured products should only form a small part of a diversified portfolio, and it is very important you understand the risks. You should not consider structured products if you are not confident you can hold them for the full term.

Growth plans typically incur capital gains tax (CGT) but you can offset this against your annual allowance, currently £11,000. They could be used for CGT planning, according to Mr Lowes, because if you hold plans with maturities in different years you could use each year's CGT allowance to offset it.

Income plans are usually subject to income tax although you can hold many structured products in self-invested personal pensions (Sipps), and some in individual savings accounts (Isa).

Structured investments have been accused of being opaque over charges because these are built into the product. Provider literature will typically set out a maximum range of what you will pay. But this can make it hard to compare products and you cannot know exactly what you are paying upfront.

However, Gary Dale, head of intermediary distribution - structured equity derivatives at Investec, says: "Charges usually very between 3 and 5 per cent over the full term of a product so between 0.75 and 1 per cent a year."

Open-ended funds have typically had annual charges of around 1.5 per cent, and consequently higher total expense ratios (TERs). But with the introduction of clean share classes many now have annual charges of just 0.75 per cent. Tracker funds and exchange traded funds typically have TERs below 1 per cent.

Structured products are also generally only available via advisers or platforms, so you will also have to pay their fees.

 

Structured investments to buy now

Products open at the moment include Walker Crips Dual Index Plan (FTSE & EURO STOXX) Issue Two which offers potential for a 12 per cent gain on the net investment for each year held, in which both the FTSE 100 and EURO STOXX 50 indices close at, or above, their respective initial levels. It has a European barrier of 40 per cent and its charge is not expected to exceed 1.5 per cent.

Mr Lowes also likes Meteor EURO STOXX Supertracker Plan June 2014 as it offers potential for growth at maturity equal to 10 times the rise in the index subject to a cap of 70 per cent of the amount you invest. It has a European barrier of 40 per cent and the maximum charge is be 2.5 per cent of the net investment.

Alex Reid, adviser at exhibit 3, doesn't strongly recommend any equity-linked structured products with the market so high, but says if you are still interested you could try Morgan Stanley FTSE Defensive Supertracker Plan 2, which pays out 3.3 times any FTSE rise until 2020 up to a maximum of 66 per cent. "This will perform well if we have a market that is moderately higher in six years' time," he says. "That scenario is likely as it is hard to see FTSE repeating the performance of the last five years. The downside is if market drops 50 per cent, in which case you could incur a capital loss."

For income he likes Morgan Stanley FTSE Defensive Kick Out Plan 17, which pays 8 per cent income, and redeems if FTSE is greater than 95 per cent of its initial level. Capital is at risk if FTSE falls 50 per cent.

"Morgan Stanley offers a bit more return than some, without having the counterparty risk of those with lower credit ratings," he adds. "I would avoid those products that offer exposure to only a few stocks. There are quite a few about at the moment but it is too easy for one stock to have a problem which ruins the product return."

You can find lists of structured products that are currently open to investment on website www.structuredproductreview.com, as well as detailed information on the plans, the providers' brochures and information on structured products.

Structured deposits

Structured deposits are fixed-term plans linked to the returns of an investment but your capital is not at risk. Instead of receiving interest at a set or variable rate as with a bank account, your return depends on the performance of an underlying asset such as the FTSE 100.

These can be better returns than a cash deposit but not potentially as good as structured investments. A deposit plan might offer 20 per cent return on the capital after three years as long as at the end of the investment term the FTSE 100 is at or above the level at which the investment started. If it falls below you will not lose your capital, although the value of this will have been eroded if inflation has increased.

"These offer the potential to beat cash for investors who don't want the volatility of assets such as equities or property," explains Alan Lakey of Highclere Financial Services. "However, you lose your instant access to the cash. You could hold these as part of a balanced portfolio which includes some cash you can access instantly."

A key difference between structured deposits and structured investments is that deposits are covered by the FSCS as bank deposits, so in the event of the deposit taker becoming insolvent investors can receive up to £85,000 per institution.

Mr Lakey likes structured deposits offered by Investec and suggests that for better rates you opt for longer-term plans of around five years.

Open structured deposits include Investec FTSE 100 5 Year Investec Deposit Plus Plan 2, Investec Even 30 Deposit Growth Plan 32, Investec FTSE 100 Kick-Out Deposit Plan 44 and Investec FTSE 100 Target Income Deposit Plan 11.

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