The "Structured Products" industry has come a long way over the last few years and in my opinion has evolved, and not devolved itself, alongside the more traditional investment markets.
Since 2007 sales volumes have grown significantly culminating in a 45% increase between 2008 and 2009. With 2010 sales figures currently standing at just over £6 billion1, we may see year end sales topping £20 billion. What makes the rising numbers even more staggering is that the growth in volumes has been achieved against a very difficult economic backdrop in addition to numerous bad news stories and significant regulatory intervention. For this reason, and others referred to later in this article, I believe that we need to go further in providing transparency and clarity around the wide range of pay-off profiles, risk mandates and product ranges available.
I have used inverted commas around "Structured Products" because I believe at long last, the Financial Services industry is beginning to recognise and realise that to categorise such a diverse and varied product set under one heading is no longer appropriate. A product name or title should also describe, albeit very succinctly, the type of product that the investor is buying and to my mind "Structured Products" is not a clear enough description. For example, if an investor buys an equity income or growth fund, corporate bond fund, exchange traded fund, tracker fund or emerging markets fund, they will be instantly aware of the type of fund they have bought. Also, "Structured Products" are not an asset class, they are simply another way for an investor to access a specific asset class in a pre-defined and, sometimes, more efficient way so I believe we should better describe the individual structures and plans in addition to separating Structured Deposits from Structured Investments.
It is worth reminding ourselves that the recent FSA reviews into the advice given to clients who invested in Structured Investment Products backed by Lehmans, clearly differentiates between Structured Deposits and Structured Investments. Structured Deposits are cash based term deposits, like a fixed rate bond, with a variable interest payment linked to the performance of an underlying asset. Structured Investments on the other hand are designed to offer investment growth or income with performance linked to an underlying asset like the UK stockmarket.
Unlike the current election system where the public will have to make a very distinct choice over which party they believe will better serve UK plc, I don't believe that advisers should decide upon a "Structured Product" and then choose either a Structured Deposit or a Structured Investment. Both offer very different pay-off characteristics and risk profiles and therefore should be used in very different ways within a client's wider portfolio. Although linked to an underlying asset such as the FTSE 100 index, Structured Deposits are cash based products and should be used as alternatives to cash deposits. They are taxed in the same way as cash deposits and are afforded the same protection. They are covered by the Financial Services Compensation Scheme (FSCS) for the first £50,000 of each eligible claim for an individual and therefore up to £100,000 for jointly held assets. Clients with cash savings will usually utilise short term savings products such as instant access or 90 day notice accounts or perhaps use a fixed rate bond over say a 3 or 5 year period. All of these plans offer return of capital plus a fixed rate of interest. Currently the best rates of interest on offer are 3.03% pa for a 90 day notice account or 5% pa for a 5 year fixed rate bond2. Alternatively, Structured Deposits offer return of capital plus a variable interest payment so in essence the client is swapping a fixed rate of interest in return for a variable rate which can be higher. Investec Structured Products offer a range of deposit plans which are designed to return the initial deposit at maturity and, at the same time, to outperform the returns investors could expect from cash investments. For example we have a 3 and a 5 year deposit plan offering return of capital plus a fixed return of either 16% or 37.5% respectively provided that the FTSE 100 is higher at maturity. We also offer a deposit kick-out plan and a deposit income plan and some of our deposit plans pay adviser commissions of up to 3%. These are compelling plans that can be used for clients looking for alternatives to cash deposits or investors looking to protect their assets from falls in the investment markets. Structured Deposits do not carry the same inherent risks as Structured Investments and Icesave is a recent example which highlights the willingness to fully protect all deposits.
Structured Investments on the other hand are designed to deliver asset growth, or income, as either an alternative or a complement to equity or fund investments. They carry both investment risk and counterparty risk and should only be used where the client has an understanding of the full risks involved including potential loss to capital. The FSA has underlined the point that Structured Investment products would be unsuitable for clients who have no capacity for capital loss. The FSA has also offered guidance around product and counterparty concentration risk and also produced a template to complement the advice process. Advisers should be able to utilise Structured Investments within a client's investment portfolio whilst at the same time accessing upside and minimising downside in an efficient way. Investec Structured products offer a continuously available collection of Structured Investments with risk adjusted profiles to suit a wide variety of investor needs. We also offer a choice of counterparty, RBS, on two of our plans to give the client more choice and allow them to diversify risk within the same Plan. Whereas traditional funds require the underlying assets/indices to grow in order to provide real returns, many Structured Investments simply rely on the underlying asset(s) not to fall whilst still generating performance upside. Structured Investments are generators of beta and, it could be argued deliver this in a more efficient way than many traditional funds which are sold, in many cases, on the basis of one manager's alpha and processes outperforming another. In isolation, both investment disciplines have their merits however it would seem sensible to think that by combining different strategies together, the desired upside performance would, by definition, become a more realistic outcome.
Having said all of that, clients tend not to buy only cash or investment products, so why would they choose a "Structured Product" and then pick either deposit or investment? Surely consideration would be given to the holistic nature of the strategy or portfolio before any specific product was chosen. Clients buy products that are appropriate to their needs at a given point in time or that will be required in the future. In addition to risk and capital loss, factors such as current and future taxation need to be considered, matching return profiles to meet specific needs and also liquidity are important so it is very unlikely that one specific strategy is likely to cater for the varying needs of today's investor. Structured Deposits and Structured Investments are fundamentally different in many ways therefore full consideration should be given to, not only each structure in isolation, but as to how they might work within the portfolio planning process.
1 Source: www.structuredretailproducts.com
2 Source: www.moneyfacts.co.uk - 4 May 2010
