What are 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.”

Retail customers generally struggle to understand the complex features common to many structured products and frequently overestimate the potential returns available from them.--FCA

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.

Structured products offer investment strategies which can do things that neither active nor passive fund management can do.--Chris Taylor

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.”

Chris Taylor, global head of structured products at Tempo, says another key feature of structured products is that firms have a contract to keep their promises:

“Structured products offer investment strategies which can do things that neither active nor passive fund management can do, in particular this includes the ability to generate positive returns from a flat or even falling market, with a defined level of protection from market falls, and to do so ‘by contract’," Mr Taylor adds.

"For example, structured products equate to investing by contract, creating a legal obligation upon the issuer to deliver the terms of the bonds which they issue, which in turn creates the counterparty risk.”

Types of structured products

Rather than being a single-functioning product in its own right, structured products come in a few different shapes and sizes.

According to Meteor Asset Management’s website, these are as follows:

• Autocalls (or kickout) are structured products which can mature prior to their scheduled maturity date, if certain predetermined market conditions have been met.
• Income products are market-linked investments that can provide an enhanced level of income.
• Growth products are market-linked investment   s, which aim to return a growth payment and initial capital at maturity of the plan. 
• Structured deposit plans are cash-based fixed term deposits, like fixed rate bonds, but instead of paying a fixed rate there is a variable return linked to the performance of an underlying asset.

Ian Lowes, managing director at Lowes Financial Management, offers some further detail.

He says: “Since the demise of capital ‘protected’ plans in 2015 the market can be split into two main categories: capital at risk which, year to date represent approximately 81 per cent of plans issued and deposit-based plans which make up the balance.

"As the names suggest, deposit-based plans are expected to return a minimum of the original investment at maturity and also afford Financial Services Compensation Scheme protection in the event that the deposit taker defaults, whereas the alternatives typically put capital at risk from counterparty default and market falls beyond a contingent capital protection barrier.”

He adds that the capital at risk sub-sector can be split into three main categories; growth plans, income plans and auto-call plans with the latter being dominant, representing 70 per cent of plans issued year to date.