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Pros and cons of structured products

This article is part of
Guide to Structured Products

Capital at risk products have been used to deliver high single and double-digit returns and to provide some peace of mind in respect of capital, in volatile market conditions where stock markets have done little more than track sideways, Mr Lowes adds.

Mr Lowes says: “The qualities of structured products - defined outcomes based on defined market conditions, plus potentially a degree of capital protection, and the ability to deliver in flat or even falling markets– means they can be useful tools for adviser looking to achieve balance and diversification in investment portfolios.

“Structured products also can be used to take a view on the markets – for example, an adviser who believes the markets will go up but not by very much over the next year might buy an autocall which has the potential to mature early (on an annual anniversary) to deliver a potential gain and return capital, allowing reinvestment into another product or fund at that time.

“Similarly, an adviser who believes the markets may range trade, might buy a defensive structure that gives, for example, a set return if markets fall anything up to 20 per cent over five years.”

As with any investment there are risks involved with structured products.

Counterparty risk is the possibility that the counterparty to the product might go bust and not be able to meet its contractual obligations.

Mr Lowes says no one can say that a bank will not fail but use of credit rating agency ratings, looking at CDS spreads and, if an adviser wants to go that far, looking at bank balance sheets, can help mitigate the risk.

Market risk is another factor.

There is always the possibility that markets might fall so far that protection barriers are breached and investors will lose capital - although Mr Lowes points out typically barriers are set at 50 per cent of the index strike point and if the stock markets were to fall by that large a figure then markets would be in crisis and all other investments would also be massively affected.

Another market risk is that at maturity markets are down and no gain is achieved so only capital is returned, in which case inflation may have eroded the real value of the capital.

However Adrian Neave, managing director of Gilliat Financial Solutions, says one of the benefits of structured products is they are relatively straightforward for investors to grasp.

Structured deposits are like straight forward bank deposit accounts, according to Mr Neave, with the difference being interest is calculated by reference to a formula.

An example might be that there will be an interest payment of 5 per cent as long as the FTSE 100 is more than the level it was at when the original deposit was made.

The level of the index might be observed every 12 months and if it is higher the client receives interest of 5 per cent, if it is lower no interest payment is made.

Mr Neave says the attraction of structured deposits is they will typically offer potentially higher interest than conventional term deposits, however there is obviously the risk of there being no interest if the reference asset does not perform.