In the current economic climate many would-be investors are reluctant to invest directly in the stockmarket.
Inland Revenue figures reveal a 21 per cent drop in the number of maxi Isas taken out in the 2001/02 tax year as mini cash Isa sales rose by 26 per cent.
Lipper Hindsight shows that, as of July 31, 2002, the FTSE 100 was down by 22.3 per cent compared with a year ago and by 30.9 per cent compared with two years ago.
Stockmarket volatility has left many consumers unsure where to invest their money or if they should invest at all. In the words of one would-be investor who took part in a research project conducted by Bacon & Woodrow earlier this year: “The money is sitting in a deposit account, waiting to see how the present market problems pan out.”
Given this backdrop, it is not surprising that many people are finding structured products attractive. Structured products offer the potential for high returns dependent on the performance of an indicator. Typically, these are threeto five-year products where the headline return rate is linked to the performance of either a basket of shares, an index or a group of indices. The capital is returned in full at the end of the term provided that the chosen indicator does not fall below a pre-defined level during the term or is not below some pre-defined level at the end of the term. The investor's capital is only at risk if the pre-defined level is breached.
The degree of capital protection offered should always be made clear to the investor as it is easy to be attracted to the prospect of high levels of income or growth without really understanding the associated risks. A protected investment can reduce the likelihood that their capital will shrink but it does not offer any steadfast guarantees.
Structured products have an important role to play, especially in the current environment. From the IFA's point of view, there is a large choice of products. However, comparisons can be difficult, given the varied nature of some of the plans on offer, while investors and advisers also need to be aware of some of the little tricks that providers can use to artificially enhance a product's headline rate. The repertoire of tricks include:
The misleading timeframe
This trick requires the investor to tie up his or her money for longer than the published term of the investment. The headline rate, however, is based on the published term.
The omission of charges
This is another illusion based on the headline rate. This time the headline rate advertised ignores explicit charges.
Naturally, when the explicit charges are deducted, the headline rate magically disappears and is replaced by a lower rate.
The varying final index level
Here, the final index level is calculated by looking at the lowest index level over a long number of weeks. It is not unreasonable to use a short end period but the number of weeks can vary significantly, with some plans using up to 12 weeks.
The growth at risk trick
This concerns growth products. Under income products, the income is guaranteed, regardless of what happens to the capital at the end. The same is not true of all growth products. Some providers guarantee that the growth element will be repaid, regardless of the final index level, but this is not true for all plans.
The multiple indices illusion
This comes into play when returns are based on a number of indices or, worse, a basket of stocks. Using multiple indices or stocks to calculate the return increases significantly the chance of a breach in the barriers for one or more of the indices or stocks.
The income is increased by selling the underlying options, allowing a higher headline rate to be offered.
For capital to be returned in full, the index either must not fall below a certain level or must not be below the trigger point at the end of the plan.
These little tricks are clever ways of enhancing the headline rate on offer. They do not undermine the usefulness of structured products but are worth remembering and considering when choosing between plans.
You can easily avoid plans that use these tricks as there is no shortage of plans to choose from.
At the end of the day, structured products offer a degree of protection and reassurance to many investors who might otherwise choose not to invest. They have their place in the right portfolio.