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Structured argument

Banks are keen to stress the benefits of structured products. Many clients seem to agree as a recent report from BNP Paribas showed that global retail sales of structured products grew by £15.8bn in 2005 to exceed £155.4bn.

The UK has trailed much of continental Europe in demand for structured products. Sales of structured products in the UK rose from more than £5bn in 2001 to just over £6bn in 2004 although sales were less than £1bn in 1994. Despite this, it is estimated that at least 20 per cent of wealthy investors own these products.

The structured product industry has evolved over the past few years from plain vanilla 100 per cent capital protected funds to more “innovative” products. These include locking in returns and constant proportion portfolio insurance.

By using the CPPI structure, the provider can allocate 100 per cent of assets to the underlying investment from the first day of the product and not have to buy a note to cover the guarantee. But the provider has to ensure it has sufficient assets to move into cash or buy a bond at any point during the term of the product to cover the guarantee.

Banks argue that there are a number of attractions of structured products, including the ability to offer 100 per cent capital protection and gear upside returns.

The new Luxemburg-based SG Adequity enhanced growth UK tracker product, for example, offers 185 per cent of any growth in the FTSE 100 and 100 per cent of any fall in exchange for no dividends. Investors need to believe the FTSE 100 index will deliver capital growth of at least 4 per cent a year on average over the next six years.

Structured products also provide access to asset classes that are often out of reach to retail investors. These include commodities, commercial property and hedge funds.

NatWest International Personal Banking senior product manager Mike Dixon says: “Commercial property is not a very liquid market and investors need high minimums to access it. Instead, investors can buy a structured product that is linked to a commercial property index.”

Structured products can usually be launched quicker than unit and investment trusts and thus take advantage of “hot” investment themes.

The popularity of these products has been boosted by the volatility of stock-markets, notably the three-year bear market between 2000 and 2003. Dixon says demand has also increased because of negative publicity surrounding with-profits bonds.

Credit Suisse Private Banking head of investment solutions Craig Lewis argues that structured products provide more certainty of returns than funds. He says: “If the underlying index rises 10 per cent, you do not know the returns that will be delivered by a fund. In contrast, if an index delivers a return of x then you know the structured product will return y.”

Many structured products are domiciled offshore. There can be tax advantages of using offshore products although establishing a Dublin-based company may be more expensive than launching a UK product, says Lowes Financial Management managing director Ian Lowes.

Lowes says an increasing number of products are now domiciled in the UK but one of his current favourites is based in Dublin.

The NDF growth kick-out plan is a six-year product and returns 11 per cent a year on any anniversary in which the FSTE 100 and Nikkei indices are both at the same or a higher level than at the launch of the product. At this point, the product closes and the 11 per cent return a year is backdated to the start of the product.

Capital is 100 per cent protected unless either index falls by 50 per cent at maturity. If this occurs, capital will be reduced by 1 per cent for every 1 per cent in the worst-performing index below its start value.

In choosing structured products, investors should evaluate a number of factors. These include the potential tax liability. Are gains liable to income or capital gains tax?

Look at the index the product is linked to, the term of the product, what targets must the product reach to deliver a gain, can the product be terminated early by the provider, is the original capital guaranteed and what are the circumstances under which the capital is at risk.

Supporters of structured products argue that they are suitable for clients with different objectives and risk profiles. Lewis says there is still strong demand for 100 per cent capital protected products. “Clients want protection against market falls while gaining exposure to the underlying market and thus a potential upside return,” he says.

He adds that if clients have generated returns from equities, they may want to lock in these gains by switching into a protected product. “This allows clients to take risk off the table while enabling them to benefit from potential upside returns. But if investors think markets are most likely to rise then they can use structured products to leverage their exposure to try to enhance returns.”

Dixon says structured products can be designed to meet the individual requirements of any clients. These will be constructed to deliver the level of return desired by clients and the degree of protection they want. This usually requires at least £500,000 in assets.

But structured products are not universally popular. JS&P financial planner Patrick Connolly says it does not use structured products. He says: “We have never been able to find a product whose price we believe is worth paying. Investors do not see the internal workings of structured products and the charges. Typically, there are charges of 7.5 per cent to 10 per cent over the term of the product.

“We looked at the possibility of structuring products ourselves and trying to keep costs to a minimum. But we decided risk management and achieving clients’ objectives was better served through asset allocation and diversification.”

Other reasons why Connolly is cautious about structured products include the fact that they pay no dividends from equities and the lack of flexibility over the term of the investment.

“You cannot redeem early or remain invested if you feel the market environment favours this strategy. Structured products may also not be tax-efficient.”

Connolly adds that a diversified portfolio can manage risk. “If a client is cautious, we increase the exposure to cash and bonds. It is possible to give a guide to the maximum return and maximum loss with each asset allocation.”


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