In the 1970s, a new breed of retail investment came to the UK market and advocates of more traditional investments were highly critical.
As the new breed gathered momentum, the critics cited any failure or problem, big or small, as evidence for their case. But by the early 1980s, the market regulated itself and there had been a gradual acceptance that the new type of investment may, in fact, be better than traditional with-profits.
Today, what started life as the upstarts of the investment industry are significantly more prevalent and it is widely accepted that, in most cases, unit-linked products are better than those based on the with-profits concept.
In the early 1990s, another innovation – stockmarket bonds – began to appear in the UK market. Back then, there were only one or two bonds on offer at any one time and they went widely unnoticed.
The market slowly developed until, by 1999, the inevitable occurred and some marketeers and product developers let greed take the place of common sense. As a result, while some of the investments on offer were reasonable, others were diabolical.
The first article warning about what ultimately became known as precipice bonds appeared in the Sunday Telegraph in October 2000. It was a further two years before the rest of the mainstream media began writing about the impending disaster and when many of these plans matured in 2003, some investors lost nearly all their invested capital.
However, not all such investments were poor and there were plenty of other stockmarket bonds that continued to produce attractive returns. Any adviser in the market who had put common sense before greed was therefore unaffected, as were their clients.
Today, these investments are known are as structured products and while the limitations and pitfalls inherent in many of the precipice bonds have been regulated out of the market, just like unit-linked investments, some structured products are good, others not so good and, as ever, an adviser’s role is to sort the wheat from the chaff.
They come in all shapes and sizes but, in general, a structured product is an investment product (or plan) where the return is defined by reference to an underlying measurement (such as the FTSE 100 index) and delivered at a predefined date. Unlike unit-linked investments, they do not rely on an investment manager getting things right and they usually include a degree of protection against falls in the stockmarket or whatever the under- lying measure is.
Structured products will never replace unit-linked investments but they are gathering pace as the UK market slowly catches up with the rest of Europe. More and more advisers are accepting that, chosen wisely and used appropriately, structured products can be a beneficial element of many portfolios.
But in the same way that precipice bonds clouded the market, the collapse of Lehman Brothers, Keydata and NDF has provided fuel for the critics.
Lowes has recommended many Keydata and NDF plans over the years and these have provided some of the best returns for our clients. For example, two Keydata plans we promoted in 2003 matured in September 2009, each producing gains of 60 per cent against average increases in the cautious managed unit trust/Oeic of only 24.1 per cent and 26.5 per cent over the same investment periods.
Also, despite a turbulent six years, the capital protection built into these plans remained throughout.
Unfortunately, Keydata got into trouble in June this year due to its involvement with investments that were not structured products and which Lowes, thankfully, had avoided. As a result, while all of Keydata’s structured products were backed by substantial institutions and remain intact, Keydata is, in effect, no more.
All structured products are dependent on the ability of the counterparty to meet their obligations. If an investment is backed by a small, poorly rated bank, it is likely to offer better terms than a plan supported by a stronger institution but, of course, it carries more counterparty risk and, if the bank goes bust, investors could lose their investment. Lehman Brothers was anything but small or poorly rated and the collapse was cited as a once in a century event that no one could have predicted but it did serve to highlight counterparty risk.
A good adviser’s job is to consider all the risks in the context of all the known and relevant factors.
The collapse of Lehman Brothers also ultimately led to the downfall of NDF Administration, as some of their plans were backed by Lehman. The collapse of the bank meant investors were facing the potential of total loss so, given the culture we live in, the clients and their advisers understandably looked for someone to blame.
For some, it was not too difficult. For example, there is the well quoted case of the capital secure fixed growth plan, which, it could be argued with the benefit of hindsight, was inappropriately named.
Many investors could maintain they were misled as to the risks and because NDF did not have sufficient insurance to cover the potential claims, it went into administration. As such, the claims may ultimately have to be handled by the Financial Services Compensation Scheme and, no doubt, many will be upheld.
But what about those who invested knowing the risks? I do not expect the FSCS to issue compensation in such cases but where does that end? Or what about the client who invested after having the risks properly explained and documented? Arguably, having “capital secure” in the title will be enough to sway the decision but you can see the difficulties facing the complaint handlers.
As to those NDF/Lehman investors with no claim against NDF, as senior, unsecured creditors they should ultimately recover something from the Lehman wreckage. But who will fight their corner? I know Meteor has been defending its clients and, hopefully, under Grant Thornton, NDF is doing the same so that investors do not miss the November 2 deadline for claims.
Over the last decade, NDF has been responsible for some of the best and worst structured products, and, as with the problematic Keydata plans, no Lowes’ clients have been exposed to any of the latter and the rest remain intact.
However, NDF’s demise will not be good for the market. It will reduce competition and hand more power to the banks. Hopefully, someone can pick up where NDF left off while benefiting from the lessons learnt.
In the case of structured products, as with unit-linked and other investments, there have always been good opportunities on offer and I expect they will continue to represent an important and beneficial element of our clients’ portfolios.
Be wary of anyone who indiscriminately criticises the whole-of-a-market sector as, in my opinion, they either have a vested interest or do not have the requisite knowledge.
Lowes has relaunched its structured product review service at www.Structured-ProductReview.com. This free service for IFAs compares many of the plans on offer, will keep you up to date with new plans and we will even tell you which ones we like.