The FCA has suggested improved disclosure of likely payouts and other changes after research revealed investors were overestimating returns from structured deposits.
The 52-page FCA occasional paper, Two Plus Two Makes Five? Survey Evidence That Investors Overvalue Structured Deposits, warned retail investors had shown a limited understanding of structured deposits.
The watchdog designed five stylised structured deposits of increasing complexity, drawing on previous analysis to ensure these broadly represented the UK retail market as of early 2013.
In an online survey, it described these structured deposits to retail investors and tested their understanding of them using multiple choice questions.
The survey asked respondents what they expected the products to pay based on an initial £1,000 investment and the equivalent yearly rate of return and how likely the products were to outperform two benchmarks.
The survey also explained the FTSE100 and asked investors how they expected the index to perform over the next one to five years.
Investors were also asked to compare three of the structured deposits to risk-free cash deposits. After this, they were given information about the risk and likely payout associated with the products under various scenarios.
The research, among 384 retail investors, found they had overestimated returns by a mean average of 1.87 per cent a year.
The paper said: “Our findings suggest that investors’ understanding of structured deposits is limited: expected returns are consistently overestimated across all five products, even after controlling for investors’ expectations of the underlying index, and also appear to distort the valuations when comparisons to alternative risk-free substitute products are made.”
The FCA asked whether firms should use non-advised sales channels to sell structured deposits to retail investors.
It suggested that costs could be disclosed as a separate fee rather than being deducted from the investment amount or built into products.
The FCA also asked whether disclosure on information such as likely returns could be improved.
Scott Gallacher, chartered financial planner for Leicestershire-based Rowley Turton (IFA), said: “Clients have a tendency to underestimate risk and overestimate returns, but I think structured deposits should be fairly easy to understand.”