Perhaps the single biggest question I am asked about is structured investment products and they bore me senseless.
These are the products you will see listed in bank windows or sold over the phone/direct mailers.
They are sold as protecting the downside of your money with an element of return on the upside and are, in most cases that I see, sold to risk averse investors as a reasonably simple straight forward investment.
However, these structured products (often murmured or muttered as guaranteed) are singly the most complicated investment you could consider for your capital.
I really couldn’t imagine why so many of these products were being designed but when you look at the profit they make for the banks for a quick sale it’s a little easier to understand.
It is unlikely after reading the true information about them that any investor would consider investing in the mainstream products on the market place but if you have been offered one (rather – sold one) let me know and I will gladly review it.
I am hoping to never have to answer a question in relation to these plans again and at the same time explode the sales lure of ‘you can have the return with no risk‘. Structured products are so complicated; I will cover them over a number of columns.
The whole ‘structured product sale’ starts with a poor communication in relation to risk.
Many customers are asked embarrassingly non specific questions about risk, such as ‘what risk rating are you from 1-10? ‘, or ‘here is a pyramid with cash/building society at the bottom and high risk Japanese warrants at the top, which risk are you?'.
Invariably when you are asked a stupid question your answer will have to be of the same quality and it is this poor questioning around risk that has lead tens of thousands of customers (particularly of banks) to buy such poor quality contracts.
Few financial advisers really want to explain risk as they fear the customer may not want to invest at all so they skim over risk and reward.
This section of your financial advice should take you between 1-2 hours.
It is from this starting point of poor questioning that investors follow on the trail of structured contracts believing them to be a win-win solution where you can only lose in ‘extreme’ situations but can gain all round. This is highly misleading.
A structured contract is a plan that is prepared by a product provider and more specifically for the product provider.
Unlike a normal investment where you buy shares or property directly, these arrangements tend to buy a range of complex instruments to achieve their objectives and you wouldn’t begin to understand, not only how complicated they are, but also how difficult they are to stress test against market downturns.
For example, they may offer 80% of the return of the FTSE all share index as long as the FTSE all share doesn’t fall by more than 50% and not recover.
In order to achieve this, the company buys a ‘promise’ from a provider (counterparty) such as RBS, Lloyds etc which provides an annual return, which in turn provides the capital protection at maturity.
In simple terms, if the annual return (promise) was 6%, the provider of the structured product might have to place c75% of the original investment with the counterparty and that would provide the 100% capital return after the five years. The remaining 25% will go towards a mixture of charges and the purchase of complex derivatives in the stock market. It is this 25% which provides the 80% upside participation in the FTSE100 as above.
Investors in structured products often do not realise they are missing out on the dividends of the FTSE 100 and also that if the counterparty fails they may lose everything. More on that next week.
Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'