Wayne Riches, client relationship manager for Britannia International considers the potential applications of structured products and the growing choice now offered as the market evolves
Dip into any current publication for intermediaries and you will no doubt see a feature on structured products. One of the significant growth areas of past years, not only has the number of providers of these products increased but the complexity and variation of new launches appears to know no bounds.
To assist advisers researching the variety of products now available there is also an increasing number of websites, such as www.futurevc.co.uk and www.structured retailproducts.com, which allow advisers to view and compare the features and details of each product.
But while advisers have become more comfortable with the concept of a structured product, not everyone is as clear on their potential applications.
Many advisers compare structured products with direct equity investment. Although this is worthwhile when comparing with structures that place the investors' capital at risk, it is difficult to see the merits of such comparison when using capital safe investments such as structured deposits.
If a client is willing to take a risk with the capital to be invested, generally they would be better investing directly into equities rather than investing in a structured product linked to equities.
However, if a client is not willing to take a risk with the capital to be invested, then standard deposit accounts, structured deposit accounts and structured products which protect the original investment are likely to be the only investments to consider.
Risk vs return
Once you have established that the client is a capital safe investor (as well as how long funds can be invested for) the next consideration is how much of the income/interest the client is willing to take a risk with.
For example if a client could currently obtain 4.50% in a standard deposit account, are they willing to take a risk with all the 4.50% of income or only a proportion of it?
If they are willing to forego all of that interest in return for better potential growth then capital guaranteed products are ideal in this situation, and there are plenty of products in the market which offer 100% growth or more of the FTSE, S&P or a combination of indices while still guaranteeing the original capital.
Some of these also offer a kick-out option where they will mature early if a certain pre-determined point of growth is reached. Others may 'lock in' a certain percentage growth if it occurs at any time over the full term of the investment. Obviously it will depend on the client's opinion on equity growth as to whether these options are desirable against a more straightforward overall growth product.
In the event that a client is not willing to give up all the interest, then there are investments that guarantee a minimum return at maturity (usually around 3%-3.50%) plus the potential for capital growth linked to the FTSE 100, or a combination of indices.
Other options for clients who wish to continue to receive a level of income are investments that split the capital to be invested between an income and growth account, often known as 50:50 bonds. These may either offer a fixed rate element on the income side or a variable rate linked perhaps to base rate. These products give the client the advantage of exposure to stock market performance while still maintaining a reliable source of income.
This last variation can also be appropriate for clients requiring interest in possession trusts.
Under the rules of conversion and apportionment, trustees have a duty to consider the interests of all beneficiaries and cannot favour one class of beneficiary against another. This is particularly important where one beneficiary, for example, a life tenant, is entitled to all the income, but another, the remainderman, is entitled to the capital. The interests of each will differ but the trustees must be fair to each in their investment decisions.
Products such as an income and growth bond offer both an income account and a growth element within the one product. For example Britannia International's recent Guaranteed Income and Growth Bond allowed up to 50% of the total investment to be paid into an Income Account, which offered an annual rate of 0.75% above the prevailing base rate (equating to interest of 5.50% gross p.a./A.E.R.).
A minimum of 50% and up to a total of 100% of funds could be invested in the Growth Account, which guaranteed a complete return of capital at the end of the term plus a return equal to 100% of the average growth of two leading stock market indices over the investment period - the FTSE 100 Index and S&P 500 Index.
If the investment was spread across the two accounts on a 50:50 basis, this would have had an overall effect of offering an income yield of 2.75% for the lifetime tenant combined with the potential for growth on the investment for the remaindermen, without risk to capital.
a wider audience
At present the majority of structured products on the market are linked to the FTSE, European or US stock market indices. But from time to time it is possible to obtain a structured product based on either a commodity (such as gold) or alternative indices such house prices.
It is likely that as the market grows, the underlying derivatives will become more varied. The possibilities of linking to say commercial property or gilts, but still maintaining the comfort of guaranteed capital return, may open up structured products to a wider market. This can currently be seen in Europe where structured products have been viewed as part of the average investment portfolio for much longer than the UK.
An interesting observation from one Treasury risk manager likened the development of structured products to the development of the mortgage market. Twenty years ago virtually everyone had a mortgage on a STV basis. Now these are more the exception with fixed, tracker, flexible and offset mortgages more popular. The likelihood is that as the providers and the number of counterparties involved in structured products continues to grow, so the products will evolve offering even more scope for the cautious investor.
Joined as head of strategy, multi asset, in June
Group income protection
Nine in 10 do not have income protection
Set to become part of Single Financial Guidance Body