The current financial climate has resulted in growing uncertainty regarding the use of structured products. With once-trusted institutions hitting serious difficulties, consumers are increasingly concerned about the security of their investments; advisers need to be well-informed on the differences between the types of structured products available.
Generally, structured products have a valuable place within any investment portfolio. This is particularly true in instances when a client is looking for a particular yield, or is looking to hit a specific target - or targets - at a fixed point in time. The most common examples of these financial goals might be the provision of school fees, university fees, or a planned early retirement.
However, these structured products - as with many other financial service offerings - are not without their risk, and both adviser and client need to be very selective about the choice of product and provider. An adviser must clearly explain the inherent product risks, such as the impact of the tethered index falling through its pre-set floor, and the impact of the financial failure of the main counterparty - which is usually a bank.
In terms of the types of products offered by different providers, building society products tend to take the form of simpler cash deposit accounts taxable on the basis of savings tax at the customers marginal rate. Due to the fact that these accounts are cash based they are also suitable for inclusion within a cash Isa and offer full capital guarantees regardless of the performance of the base index.
At the other end of the scale, there are products which have very complicated payoffs aiming to benefit from a specific view of what will happen in a specific market, segment or commodity. These are often designed for high net worth customers, are regulated products and are eligible for beneficial CGT tax planning. They also often are not totally capital protected with a floor of , say, 50% which if broken and not recovered would make the customer liable to significant losses.
Advocates of structured products will argue that although they might be highly sophisticated under the surface, the basic premise of what they set out to do is understood by most investors. Critics will point to the false sense of security that the products can create and the suspicion that the upside trade-off and the frequently impressively high fee-charging structure mean that the provider is trading off investor insecurity.
There is also the general problem of a lack of liquidity. Investors will typically tie into a product for three or five years, for example. In uncertain times, this tie-in may seem unacceptable for many investors. This lack of liquidity may obviously prove to be less of an issue where Sipp monies (for instance) are concerned.
It is difficult to make decisions on the suitability of structured products based on the current market situation. Just because the market may happen to rise today does not mean that it will continue to rise throughout the life of the product. This issue is really the main difficulty that advisers and their clients have when considering entering a structured product.
In this situation, questions such as these naturally arise:
- If you believe that the market is likely to rise over the life of the product, why cap your upside by entering into a structured product?
- If you believe that the market is likely to fall over the life of a product, presumably then you are also prepared to believe that the floor of the tethered index could also be breached, with all of the adverse consequences that this would entail?
- At this point in time, the stock markets look like good value in the medium term - of course this could change but with such a relatively low starting point there is the clear potential for excellent gains with structured products. Customers are in a flight for cash at present and guaranteed structured deposit accounts can provide a way to maintain cash holdings whilst still earn potential returns form the markets.
That said, apart from cash, many investors are looking to alternative asset classes to diversity their portfolio in the current market. Thus, the widening of asset classes within structured products, rather than just having products which are tied to the FTSE, is generally seen as a good thing by advisers. It is however questionable whether the increasing level of sophistication that this widening brings means much to the average investor.
At the same time, the investor who is sophisticated enough to appreciate the finer points of one tethered index versus another probably feels confident enough - rightly or wrongly - to invest without the need of the safety net (and associated upside restrictions and liquidity restrictions) that are offered via structured products.
Structured products are like many other regulated financial investment vehicles in this imperfect world. They certainly have a place in an investor's portfolio - even in a rising market - and are being developed to offer access to alternative asset classes to counteract the downsides of traditional offerings. However - and this is the rub - they are not suitable for all types of investors and are therefore best offered within a comprehensive package of financial advice.
Simon Pimblett is head of research and development and Jonathan Brownlow is technical adviser at The Route City wealth club
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From 1 March