Just how risky are new breed of structured product?

A type of structured product offers higher returns than less complex peers but entails clients taking on more risk: a simplistic description of ‘dual index’ products invites unflattering comparisons with the precipice bonds of the past that almost destroyed the sector’s reputation.

In fact these products, which judging by recent launches and commentary are very much in demand among advisers, are just one step away from the ‘plain vanilla’ index tracking products that have regained a degree of acceptance in recent years.

They are higher risk simply because they rely on two or more benchmarks hitting an upper threshold to pay out - or kick out, if you have bought one of the early repayment models - rather than just one.

This means that while the annual pay out could be double-digit rather than the more quotidian 5-7 per cent of many single-index alternatives, the plans may pay out less often.

Similarly, it is not just a single benchmark that needs to stay above a lower threshold to avoid losses on the original investment. And if one does trip the switch, it is the worse performing of the indices referred to that will define the amount of capital lost.

So if an investor has 50 per cent soft floor protection, even if one index loses nothing if its partner loses more than 50 per cent the investor will lose - and typically on a one-to-one ratio.

FTAdviser has seen the results of research conducted by Morgan Stanley, which launched its first ever dual index product last month and cites increasing appetite from advisers, into how much additional risk investors are really taking on with this new breed of product.

A study looking at six-year rolling windows, to reflect the life-span of most structured products, between 1986 and 2006 analysed how often single or dual index plans linked to the FTSE 100 and Euro Stoxx would have failed to return the full original investment.

Morgan Stanley’s Dual Index Defensive Kick Out Plan promised to return capital to investors at maturity should both the FTSE 100 and Euro Stoxx indices be at or above 60 per cent of their starting levels on the sixth anniversary.

From the second year the plan offers investors an annual return of 10.1 per cent if both indices are above a certain level.

For plans that similarly apply a 60 per cent at-maturity barrier dual index plans would have lost money more often than single peers, but would still only have incurred losses in 1 per cent of cases.

The average loss in such instances was high, however, with just £41,460 of a £100,000 initial investment being returned at maturity. This figure does not include annual returns may have been accrued during the life of the product.

For those plans that measure the protection barrier on a daily basis - where losses are accumulated for each day a hurdle index level is not met - the rate of failure for dual index plans is more than a third (34 per cent), compared to a more modest 24 per cent for single index products.