Paul Wright discusses how structured products can be used in a retirement planning portfolio
Alistair Darling's comments that the UK is facing its worst economic crisis in 60 years just adds to the woes of families already hit by spiralling living costs, from fuel to food to mortgage payments. As the cost of living continues to rise against a backdrop of stockmarket volatility, consumers are increasingly looking for a safe haven for their investments.
As the credit crunch continues to bite and stockmarkets remain volatile, it seems we are witnessing the emergence of a more cautious type of investor. For those looking for access to the stockmarket without risking their capital, structured products continue to be a popular choice.
The flexibility of structured products means they are able to adapt, not only to varying market conditions but also to the changing needs of investors.
With over 60 (live products with five year+ term)* different products currently on the market, one of the biggest challenges for advisers is to fully understand the different types and how they can be best used to meet the needs of their clients.
Structured products have been the popular option in recent years, providing security with steady growth or a regular income stream. With structured products, investors are able to take advantage of the potential benefits of stock market growth, but equally limit the downside risks involved.
For example, a typical structured product may offer a percentage increase linked to one or more stockmarket indices. The term of the investment is typically five or six years. If the stock market falls during the period of the investment, the capital is usually protected and returned to the investor. The amount can vary between products - usually around 100%, but sometimes higher or lower depending on market conditions and whether 'income' is being taken.
Simple guaranteed products are often structured as interest rate swaps. This means that product providers will 'swap' a variable interest rate return linked to, say, LIBOR (London Inter-Bank Offer Rate) for a return linked to growth in, say, the FTSE over a fixed term, such as five or six years. The provider of the swap is usually a large bank. Generally speaking, the product provider will get more attractive headline terms (e.g. higher participation in the FTSE) when interest rates are rising and/or the term of the contract is relatively long - such as six years or more.
Choosing a suitable product
The first thing advisers and investors should bear in mind is whether or not the capital is actually protected. Another key consideration is how high is the participation rate, which index or indices and is it capped? As always, it pays to shop around. Some products will guarantee all, or even significantly more, of the growth in the stockmarket, others will cap the growth. Remember too that, for most indices, 'growth' means capital growth and will exclude any dividends normally paid by the underlying asset.
To ensure suitability, it is also important to consider whether the index (or basket of indices) is compatible with a customer's other assets. As ever, it is important to weigh up product suitability against the combination of upside/downside. For example, an investor may wish to balance their portfolio with exposure to the property market, as opposed to the FTSE or a basket of equities/indices. Customers need to be aware of the options and understand the pros and cons of each. In particular, investors may find that, where growth is linked to more than one index, the final return is often calculated as an average - growth in one index being offset by a fall in another.
Customers should not expect easy access to their money until the end of the term. It is very difficult for product providers to unravel individual contributions for individual early access. However, some products do allow withdrawals - if this is the case, it is important to understand if there is a penalty and if so, how big.
Whether or not the structured product can be wrapped in an ISA could also be an important feature. It is a benefit if the ISA allowance is not being used elsewhere. However, tax efficiency should not take priority over whether the product provides a suitable fit for the customer's needs.
There are usually no explicit charges associated with structured products (costs are included in the terms of the swap with the counter party and reflected in product features such as the participation rate, term etc). Since it is almost impossible to isolate charges, investors need to compare product features.
Furthermore, investors should not forget that where their capital is guaranteed, the cost for the investor is in fact, the 'opportunity cost' i.e. the risk (cost) they could receive a lower return than leaving the money in a bank or building society deposit account.
As with any good collective investment, the sum is greater than the parts. Each element needs careful consideration and the final selection should be based on a combination of desired level of customer risk, preferred asset mix, optimum term and degrees of flexibility required.
While investments can be perceived by some as a complex area of financial planning, structured products can provide cautious investors with the opportunity to enjoy the benefits of stockmarket growth while protecting their initial investment in a relatively simple structure.
Whether or not structured products prove as popular in the future as they have in the past, they should be considered by advisers and their clients as part of their holistic financial planning.
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