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Advisers are urged to check collateral risk

Advisers should look at whether issuers of capital-protected structured products are covered by collateral arrangements when gauging risk, warns Schroders structured investments manager John Teahan.

Speaking at a Cofunds briefing last week, Teahan said collateral is key to reducing clients’ exposure to a single issuer, which might typically occur when a client buys a bank-issued structured note.

He warned that capital-protected structured notes are often contingent on the underlying issuer being able to meet its ongoing and senior obligations.

He said: “Advisers must be aware that they are not just giving investors exposure to a particular asset class, they are also taking on counterparty risk. They should ask how this is being mitigated and if the issuer is using some collateral.”

Schroders often employs collateralisation techniques when offering protected strategies and when using derivatives across its fund ranges but says the nature of the structure varies according to the risk-return guidelines set down in the fund and preferred by the client.

Teahan said: “Advisers need to think about collateral and not just take credit ratings at face value because the confidence in these has been diminishing.”

Lowes Financial Management managing director Ian Lowes says investors must measure up the returns that may be sacrificed by buying into more expensive protection strategies.

He says: “If offered a return that is twice as much for taking the risk that the bank could potentially default or buying a securitised contract, what are you going to take?

“Everybody has a different risk appetite and it is a case of looking at risk and the potential return on every case.

“If you are going to go down the route of collateralising everything, you might as well put everything in the bank on a deposit basis.”

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