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Structural strengths

In uncertain times, the reaction of many people is to take out insurance, just in case the worst should happen. This is no more true than in financial markets, where the growth in sales of capital-protected products in recent months has been significant. This has prompted the arrival of more and more product providers.

However, sales of structured products, of which capital-protected products are just one element, have been growing steadily for years. Sales reached an estimated £6.3bn last year – an increase of 15 per cent.

In fact, the UK market has existed since the early 1990s, when companies such as HSBC and Legal & General pioneered the use of long-term options in creating innovative new financial products. In the early years, the market was dominated by insurance companies, often looking to replicate the with-profits proposition through a less capital-intensive and more transparent product. Sales grew steadily, if unspectacularly, perhaps because the dominance of with-profits products made inroads difficult.

Over the years, however, increasing numbers of product providers have entered the market and many new forms of product have appeared to satisfy customer demand. Today, the market for all forms of structured products is increasingly part of the mainstream. According to our research, 68 companies offered more than 300 different products in 2002.

Of course, structured products have attracted their fair share of criticism over the years and financial derivatives, the underlying contracts behind most structured retail products, have recently been described by investment guru Warren Buffett as “financial weapons of mass destruction”.

The main focus in recent months has been the failure of many high-income products to return investors&#39 capital in full. Two key points are often ignored, however. First, the investor who purchased the product has typically been receiving a very high level of income during the term of the product. It should have been clear that such a high level of income would not come without some risk. Second, the reduction in their capital return has been due to falls in overall equity markets, so even investors in straightforward index-tracking funds would have seen a significant reduction in capital, without the benefit of such a high level of income.

There were, and probably still are, structured products that have been badly designed and have exposed investors to unreasonable risks. The danger is that it can tempt one to conclude that all forms of structured product are bad.

The untold story of the three-year bear market is that thousands of investors in capital-protected products have and will continue to receive a full return of capital and sometimes more.

Today, the structured product market is increasingly being seen as the natural home for investors looking for an element of capital security with the opportunity for some equity-based returns or those who need levels of income above cash rates. The transparent nature of most products, where the return is predefined and linked to a published stock-market index, can prove appealing. These products often compare favourably with traditional alternatives such as with-profits for investors seeking capital guarantees or high-yielding bond funds for investors seeking higher income.

At present, it is the former proposition that is dominating sales. Over three-quarters of sales of structured products this year have been in so-called growth products that provide some form of capital protection.

In the past, these products were targeted at conservative investors looking for a first step out of a deposit-based savings account but, increasingly, investors who have previously been happy to invest in equity-based products are looking at structured products as a way of limiting further portfolio losses without losing the opportunity to benefit if the stockmarket should recover.

Recent launches of so-called super-tracker products that provide multiple gearing to any stockmarket growth while also benefiting from high levels of capital protection are an example of how this need is being met.

This is one of the most appealing features of the structured product market. The flexibility of the underlying instruments and innovation of product providers have produced a continual evolution in product design to meet changing investor appetites. This rate of innovation cannot be matched by any other investment market and will undoubtedly continue to sustain market growth.

This is good news for investors and their advisers. Increased competition will provide a wider choice of products and enable similar products to be compared more easily. This will ensure that products remain good value as only the best-priced products will sell. After many years of steady growth, the structured product market appears to have finally come of age.


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