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Defining structured products

This article is part of
Guide to Structured Products

Graham Devile, managing director of Meteor Asset Management, says the nature of such products means advisers can explain the range of outcomes for a particular product in any number of given market situations, preparing them at outset for the best and worst case investment return scenarios.

Structured products can be designed to offer either income, participation, growth, or even a combination, linked to the performance of an underlying asset class (or classes).

In addition to the investment return, Mr Devile says structured products also aim to return investor’s initial capital at maturity, subject again to the specific product investment parameters.

A very basic definition of a structured product might be that it is an exchange of cash flows, says Adrian Neave, managing director of Gilliat Financial Solutions.

However, he says a more friendly definition for clients could be that it is a contract where a bank promises to pay the investor a return referenced to the performance of an asset (for example, the FTSE 100).

Mr Neave says: “The amount of the return is formulaic so that an investor can calculate exactly what they would receive under any given circumstance; this certainty of return versus performance is unique to structured products.”

For example, Ian Lowes, founder of StructuredProductReview.com, says a ‘capital-at-risk’ structured product might offer a return of 65 per cent on the investment if the FTSE 100 is at the same level or higher on the day the product matures in five years time.

If the FTSE 100 is less than that level, Mr Lowes says it will return the original investment amount, unless it is more than a specified amount below, say 50 per cent, whereupon capital would be reduced by the equivalent fall in the FTSE 100.

A simple structure will purchase a zero coupon bond, which is used to accumulate interest in order to return the investor’s capital at maturity, and a call option, which is used to deliver the gain, where applicable.

Mr Lowes points out such investments have been available to UK investors since the early 1990s and while past performance is not a guide to the future, they have, in many cases, helped to enhance portfolio returns while at the same time providing a degree of protection against stock market falls.

Mr Lowes says: “We believe that structured products offer many attractive features that can be used to satisfy a variety of investor needs.

“We do not believe they should be seen as a replacement but as a complement to traditional investments such as funds.

“Structured products are used as satellite investments, but increasingly, their ability to produce known returns combined with varying levels of capital protection mean they are being seen as core investments in portfolios.

“This has particularly been the case in recent years when products such as autocalls have been producing high single and double-digit returns in markets where the indices often have been only just in positive territory.”

But in extreme circumstances, such as a bank failure, Mr Lowes warns some of these investments could result in the investor losing some or all of the money they invest.