Stock market shocks in recent months have seen anxious investors unsure where to safeguard their capital as the economy grinds to a halt and the 'credit crunch' continues to bite.
While history shows that equity markets may offer the potential for greatest gains over the long-term, the uncertainty surrounding financial markets around the world has highlighted their instability. Structured products, with their ability to provide capital protection at maturity, offer a potential solution for investors who no longer want to invest directly in the current volatile markets. They can also provide exposure to a range of assets and indices enabling investors to create a well diversified portfolio.
Most structured products work by depositing the majority of the capital into a bond or cash deposit account where normal interest accrual will grow this by enough to cover the capital guarantee once the product matures. A smaller amount is then used to buy market options linked to an index, asset, or range of these, to generate the return based upon the performance of these indices or assets.
So ideally, they can make the best of both worlds, allowing investors to participate in any upside when the relevant stock market or assets increase in value, as well as benefit from the comfort that the original sum will be returned if held to maturity of the deposit.
Certainly, current murky conditions make it an ideal time for providers to launch these products, and money has been flowing into them. Interest in structured products in the UK market increased to around £7bn last year, and by the end of this year this is expected to increase again, according to RBS Global Banking and Markets Division (GBM).
Last year, the total sum invested in structured products in Europe was €800bn, and this is set to hit over €1tn by the end of this year, according to Structured Retail Products. This compares to around €6tn currently invested in mutual funds.
The growth in popularity of structured products can be attributed to their access to different markets that were previously unattainable without substantial sums to invest, and the possibility of profiting in rocky market conditions. These products offer a way of participating in various markets while reducing the downside risk and some lock in gains periodically or at specified thresholds.
The simplest UK products tend to be linked to the FTSE 100 or the All Shares Index and may offer investors a proportion of the growth in that market, over a particular period, while promising to at least return the initial deposit when held to maturity.
Some institutions may offer structured products where a higher potential reward is possible but against a degree of capital risk. With these it is possible to lose some value of your deposit if the underlying index or basket of stocks falls by a certain amount. Structured products are extremely flexible in this respect and provide a unique ability to be tailor-made such that they can suit virtually any risk/return profile; right from the very risk adverse individual through to the most adventurous.
More recently, structured products have been extended into a range of more esoteric markets and indices, like commodities, foreign indices, or particular types of company, so there is a far wider range to choose from.
Before considering any structured product, it is of course important for customers to consider the general drawbacks of these deposits. For example, structured products do not invest in the assets represented by the relevant indices. This means they do not receive the benefit of dividends paid by the companies included in the relevant index. Structured products are not a certain means of beating inflation. The original capital will be eroded in real terms over the product's life span should only the original capital be returned. Also, the deposit is locked into the scheme for its duration which means that if a saver needed to access the funds before maturity, breakage charges would be incurred and the sum returned to the depositor may be less than that originally deposited.
In the future, it is anticipated that structured products could continue to adapt and increasingly replace mutual funds in investment portfolios. Currently, they are seen as the poor relation to mutual funds, but if tough times persist for the UK market over the coming years they may come into their own. Whereas mutual funds include an element of uncertainty over whether they will deliver returns above the benchmark, good structured products set this out clearly.
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