Growing need for more clarity around structured products

Growing need for more clarity around structured products

The financial services industry has been making positive strides when it comes to transparency but now one of arguably the most befuddling areas may be about to be dragged along for the ride too.

The FCA took a pop at the structured products industry last week with its paper entitled ‘Two plus two makes five? Survey evidence that investors overvalue structured products’.

The important, slightly predictable conclusion was that most retail investors do not understand structured products and, even worse, they usually overestimate the returns they would get based on the product’s blurb to the tune of 1.9 percentage points per year on average.

This would add 9.7 percentage points to a five-year structured product, surely encouraging to a prospective buyer.

The paper also urges providers to make sure they can demonstrate they have given advisers interested in the asset class all the information possible to ensure they can subsequently inform their clients properly. Clear disclosure of fees is also suggested.

The scepticism from a journalist’s point of view comes from words such as ‘enhanced’, ‘kick-out’ and ‘protection’. It makes the products sound like they can deliver something you couldn’t get by investing directly in the market.

That might be true and I am sure there are some perfectly successful structured products out there, but the marketing buzzwords are basically serving to cloud the complicated nature of these vehicles.

As multi-manager Ryan Hughes of Apollo Multi Asset Management told me, structured products only provide synthetic exposure to the market and should – like anything else – only be invested in if those buying them understand these products.

Investors must assess all the risks, which include the credit quality of the bank providing the collateral necessary for the product to work.

Not many people saw Lehman Brothers going bust – but I bet even fewer knew the wellbeing of the US-based bank was integral to their FTSE 100 Kick-Out Plan 65 actually returning them any money. Indeed, there is an argument that the reputation of structured products has been unfairly burdened by the misfortune of Lehman having been a huge counterparty.

The UK Structured Products Association last month launched risk ratings to help financial advisers better understand the products, a move no doubt aimed at increasing transparency and convincing sceptics.

But, as the very thorough FCA paper highlights, fines were still imposed on “a major provider” of retail structured products in 2011 and 2014, including penalties for misleading promotions.

The ardent promoters of this asset class should take heed of this paper and bring about change from the inside.

Bradley Gerrard is news editor at Investment Adviser.