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Structured products have faced a war on many fronts over the past month. First Richard Saunders, chief executive of the IMA, said capital guarantees required investors to sacrifice too much upside. Then Lehman Brothers collapsed, prompting fears these so-called guarantees were subject to credit risk anyway.

But commentators have overlooked one central issue: their name. Newcomers to the industry may puzzle over the grand sweep of a label like "structured products". Aren’t all products structured? What makes these ones special?

What "structured products" have in common is, of course, the capital guarantee. In fact, they used to be known as guaranteed products, until providers were accused of misleading marketing when it transpired their so-called "guarantees" were contingent on a rising stock market. After the 2001-03 bear market, Lloyds had to pay £98m in compensation to pensioners who had invested in "precipice bonds", as they came to be known, without understanding the equity risk involved.

This is why providers now prefer a nebulous term like "structured products". Unfortunately, however, this also underlines the fundamental problem: where to classify them?

Think of a fund fact sheet. A lot of multi-asset funds in the popular IMA managed sectors contain structured products. The £32m Williams de Broe Assetmaster Balanced fund, for example, profiled in Investment Adviser on 22 September, cites an allocation to structured products of 29 per cent.

But this, in itself, means very little. In reality, these structured products mask underlying exposure to equity indices like the FTSE100. And to add to the confusion, they are hedged down to a bond-like risk profile. We have bonds dressed as equities called structured products.

The point is, like derivatives, structured products do not form an asset class in their own right. Including them in an asset allocation pie chart makes little sense. And if they are not an asset class, it is hard to know how advisers are supposed to use them.

As things stand, there are broadly two types of product on offer to retail investors: income or growth. An income plan might return, say, 7 per cent a year, or 10 per cent a year subject to a rising index. A growth plan, on the other hand, might offer geared participation in the FTSE100. Both come with a capital guarantee, which can either be "hard" – unconditional on the movement of an index – or "soft" – subject to an index not falling 40 or 50 per cent. Needless to say, the more generous the returns offered, the softer the guarantee.

Although structured products are not an asset class, advisers naturally tend to use them as such. Income plans become a proxy for bond exposure, while growth plans substitute UK equity. In the volatile equity and bond markets of 2008, the stability of structured products has proved attractive.

Last July, the IMA guaranteed sector contained £714m in assets under management. A year later, the figure had jumped to £1.3bn – an increase of 78 per cent in market conditions which saw total funds shrink. And this understates the real value of structured products in the retail market, only a fraction of which are included in the IMA sector.

But institutional investors, unlike their retail counterparts, do not buy structured products as a vague proxy for other asset classes. If they have £5m or more to invest, managers can have products hand-structured to meet highly specific risk-return requirements. “Because of the flexibility of how you can write a structured product and the terms you can get, you can design it to complement the other assets in your portfolio,” says Beccie Williams, deputy manager on the Williams de Broe Assetmaster range.

Sisouphan Tran, head of Privalto UK, a subsidiary of BNP Paribas, believes retail investors should use structured products in the same way. “The way forward is not about long-only funds or structured products, but definitely long-only funds and structured products,” he says.

This is why Mr Tran, who has recently launched a structured product to UK retail investors, finds the IMA’s criticisms misguided. “Opposing structured products and long-only funds is simply not in the interest of retail investors. Structured products do not do exactly the same job as any of the traditional asset classes. They create transition areas between them – they do not replace them,” he explains.

The problem is that Joe Investor cannot, like a pension fund manager, order a bespoke product from one of the investment banks. Instead, he is confined to the off-the-shelf market. This means he cannot dictate the "transitional" risk-reward profile that structured products offer. Nor can he dictate the timing.

“The structured products a private client can buy will have a three or four week run up period because of all the regulatory stuff,” says Ms Williams. “As professional investors, we can dictate when we strike a product. If the volatility in the market picks up, we can structure one within a couple of days.”

Besides the loss of flexibility, the other major concern with transferring this kind of institutional product into the retail market is, of course, transparency. Ms Williams echoes many industry voices by stressing that clients need to be aware of the risks they are taking.

“As multi-managers, we can take a detailed view of what the underlying exposures are. But individual investors are not in a position to undertake the research necessary to understand the risks inherent in the products they are buying,” she says.

These risks have flared up again as the chances of a bank default have increased. Previously, private investors only considered the risk that the index would fall below the 50 or 60 per cent floor set, triggering capital loss. This was, after all, what happened in the 2003 precipice bond scandal. But the latest crash has illuminated another risk: that the counterparty responsible for the capital could go bust.

“It’s happened again within five years, for different reasons,” observes Robert Burdett, multi-manager at Thames River Capital. “Although the risks are very small, they can be realised, and outside professionals like ourselves, the people who want to buy a product with a guarantee are those who can least afford any issues with it,” he says.

Laurence Boyle, lead manager on the Assetmaster range, also cites cost as a concern. “I see retail structured products where the coupon is 12 per cent, because of all the costs and commission. I can get exactly the same thing with 15 or 16 per cent,” he says, putting this down to fierce competition between the investment banks for institutional clients.

But not all professionals use structured products. Mr Burdett, for example, generates more returns from manager selection than asset allocation. “If you’re the other way round, a specific targeted allocation to assets could be seen as helpful. But for me that diminishes the whole multi-manager argument – it’s no longer multi-manager, there is no expert between the fund of fund manager and the asset class,” he says.

Structured products are useful asset allocation tools for professionals. But they are perhaps best left at that. ‘Structured’ products in the retail world are the equivalent of "tailored" suits in a department store.

MAIN POINTS

1.Structured products are often used as a proxy for equity or bonds by retail investors.

2.Institutional investors can design their own ‘transitional’ packages to fill gaps in a target-return portfolio

3.Retail investors have to rely on "off-the-shelf" products, both in terms of risk and return and strike-date.

4.Costs are significantly higher for retail investors.

5.The opacity of the risks involved also makes structured products more suitable for professional investors.