Structured Products are one of the more complex and less well-known types of investments but at NLP Financial Management we believe they can play a useful role within a broad investment strategy for our clients. This article outlines how they work and some of the different products available.
In simple terms, a Structured Product is a pre-packaged finance product offering a given return, or coupon, over a specific period of time linked to the performance of a financial instrument, for example the FTSE 100 Index. The main attractions of investing in structured products are that the potential annual returns can be quantifiable at the outset, albeit they are not guaranteed, and they provide useful diversification from other more traditional investments such as equities and fixed interest. Although capital invested can be tied up for up to eight years, most plans offer the potential for early maturity on any investment anniversary, usually from the second year but sometimes after one year, subject to the performance of the underlying index.
There is a wide range of structured products available at any point in time, covering the full width of the risk spectrum, from lower risk products to high risk. We carry out extensive research into the various structured products available to retail investors, and maintain a panel of approved products which can be offered to clients.
There are two types of product available; Structured Deposits and Structured Investments, and each product will target capital growth or income. Structured Deposits are plans with a given rate of interest, which is payable subject to the performance of, for example, the FTSE 100 Index over the period of the plan, with each plan having specific conditions. If the underlying index underperforms, investors may not receive any interest at all, but the capital invested is secure, while the products have the same protection of £85,000 under the Financial Services Compensation Scheme (FSCS), as with any other savings account.
Returns from Structured Investments usually depend on how a stock market index performs, and we only recommend plans linked to the FTSE 100 Index, rather than more than one index or individual stocks, which may offer higher returns but are higher risk. We often favour more defensive plans, which can pay out even if the FTSE 100 Index falls, even by as much as 35% during the full term of the plan. Some plans offer a “step-down”, whereby on each anniversary the measurement level of the FTSE 100 Index falls, so the plan can mature early even if the market has fallen since the start of the plan. However, there is a risk that capital may be lost if the underlying index falls significantly, typically by more than 35% on maturity.
Another risk is that the provider purchases underlying financial instruments from one or more banks, known as counterparties, and if these institutions fail or become insolvent during the term of the investment, investors may lose their full investment as they are not covered under the FSCS. Understanding the financial strength of counterparties is essential and a key part of our research process, and we will only invest in products where we are completely comfortable with the counterparty, or in some cases multiple counterparties, involved in that product.
In times when the FTSE 100 Index has fallen, investing in structured products arguably becomes more attractive, as the likelihood of loss of capital reduces, simply on historical levels of the Index. Furthermore, the returns offered from structured products are often higher during periods of stock market volatility. From a tax perspective, returns from growth plans are usually subject to Capital Gains Tax, providing the opportunity for investors to utilise their annual CGT exemption of £12,000.
In conclusion, due to the wide range of products available, their complexity and associated risks, we believe it is essential to obtain financial advice when investing in structured products. Investing in a portfolio of carefully selected products, perhaps at different times to provide diversification between counterparties and a range of maturity dates and returns, can be an appropriate strategy to adopt alongside a broader investment portfolio. Returns can be attractive relative to other investments, but it is essential to fully understand the risks involved, and due to their complex nature structured products are not suitable for all investors.
Elliot Gothold is a Consultant with NLP Financial Management Limited and can be contacted on 020 7472 5555 or at [email protected]