Financial instruments are often drenched in complexity, and a vehicle that has received its fair share of criticism on this front is structured products.
This has resulted in consumers, and some advisers too, finding it difficult to have a clear view of how the product works and consequently how to incorporate them effectively within a portfolio.
In addition, their role in the collapse of the global financial system in 2008 left them with a number of reputational bruises.
Concerns have also surfaced in the past few years, too.
In 2016, a thematic review of the sector by the Financial Conduct Authority found "that retail customers generally struggle to understand the complex features common to many structured products and frequently overestimate the potential returns available from them. This can have a negative impact on the quality of their decision-making".
The aim of the review was to get firms to “improve the way they design and then distribute structured products to investors.”
Room for improvement
The FCA, in its discovery work with retail and wholesale firms, said it had “identified weaknesses in the way some firms approach product design and governance for structured products".
It concluded that firms’ senior management must do more to put customers at the forefront of their approach to product governance, and outlined the following areas for improvement:
- Identifying a clear target market during the initial product design phase and then using this information to inform each subsequent part of the product development and distribution strategy.
- Ensuring structured products have a reasonable prospect of delivering economic value to customers in the target market. Firms must be able to determine and evidence this via robust stress testing as part of the product approval process. Products that fail this process should not be manufactured nor distributed.
- Providing customers with clear and balanced information on each product and any risks. This is particularly important for information explaining the likelihood of potential investment returns and any risk to the customer’s capital.
- Strengthening the monitoring of their products. This includes ensuring distributors have enough information about the manufacturer’s product to sell it appropriately and checking that each product is being distributed to its target market.
- Applying effective product governance to ensure customers are treated fairly (including best execution where relevant) throughout the lifecycle of a structured product.
Advocates of structured products, however, are confident that these demands are being now met, and certainly refute the FCA's concerns when it comes to performance - and say that the data supports this.
Still, historically they have struggled to find favour with a number of advisers, but this does not necessarily mean they should be removed from consideration when putting together client portfolios.
Understanding structured products
So, starting with the basics – what is a structured product?
In short, they are a fixed-term investment vehicle that is linked to an index such as the FTSE 100, or a specific investment, usually with the promise of a return of capital (at least), provided the certain criteria are met, such as the index not falling below a certain level during the product's term.
Manufacturers of the product will no doubt point to the feather in its cap which is that structured products aimed to produce positive returns in any market environment by way of a capital protection.
Nick Johal, director at Dura Capital, says: “Structured products is a generic term and could encompass anything from fixed rate loans to exotic mortgage-backed securities that largely caused the Great Financial Crisis.
"As such, like many labels, it is unhelpful and I would encourage investors to ignore any labels and endeavour to understand the potential risks and rewards inherent in any investment, be it a structured product or not, and ultimately make decisions based on facts rather than labels.”