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Structured argument

FOR

Chris Taylor, CEO of Blue Sky Asset Management

The funny thing about structured investments is that they seem to attract most criticism from those who know least about them. This lack of working knowledge is usually the result of nothing more complicated than a failure to engage with the leading providers in order to develop a detailed understanding of today’s industry. Much of the criticism directed towards structured products is often simplistic, outdated and misguided.

Few advisers would dismiss the entire mutual funds industry in one go, yet most of them do not use more than 100 to 200 funds out of 2,000. But when it comes to structured investments, some commentators lump together 100 providers issuing 1,000 products a year, with no differentiation or distinction. This is preposterous – obviously, not all providers and products are the same.

Client-centric wealth managers employ time, resources and intellect to differentiate the mutual funds universe and identify “best of breed” providers and funds. This process can and should be applied to structured investments, and a failure to do so indicates more about the calibre and approach of advisers than it does about the products themselves.

It would seem churlish to suggest that some advisers are unable to understand such products. If IFAs are capable of understanding investment portfolio planning theory, active and passive funds, multiple asset classes with consideration of market cap and style biases, diversification/correlation principles, fixed interest and commercial property, it would seem absurd to suggest the structured market requires anything unique or extra in terms of experience or ability.

Surely, the principles of an investment approach where exposure to market risk can be removed, reduced or at least defined in exchange for counterparty risk which can be transparently detailed and explained, make investment portfolio planning easier for IFAs and investors to understand. To suggest otherwise would be to call into question advisers’ ability to deal with investment planning per se, rather than pointing to any specific problems with structured products.

A further anomaly is the fact that the mutual funds industry is often judged on the highest possible industry denominator – the “star” fund manager. As such, that industry benefits from what I call the “halo effect”.

By contrast, structured investments are often judged on the lowest common industry denominator and suffer from the “shadow effect” as a result. This also makes no sense.

What is the point of an adviser highlighting the fact that a structured product which offers 50 per cent participation in an underlying market, or 100 per cent participation with a low cap on total returns, is a bad investment?

This is patently clear but also patently irrelevant if leading structured investment providers are offering 150 per cent participation, more than compensating for divi- dends – with no market downside and high caps on maximum returns.

This would be akin to an adviser stating they do not rate Neil Woodford because Jayesh Manek’s performance does not stack up.

Economic conditions have created a greater need for value-adding investment solutions than ever before. Advisers must prove themselves able and willing to identify and align “best-of-breed” investment solutions, from across the investment universe, without dogma or divide between industries – especially if based on misguided or inadequate industry knowledge.

For this reason, I am not going to deal with specific areas of relevance – counterparty risk, accounting for dividends, providing liquidity, minimising costs and providing transparency of underlying charges – because there is an ever increasing audience of receptive advisers already alert to these points and who engage with the structured investment industry positively to ensure any provider or products they work with deliver against these criteria.

Suffice it to say that all these issues may indeed be valid criticisms of “bottom- or third-quartile” structured product providers, if such a quartile ranking system existed, and certainly do not apply to leading providers who deal with them on a day-to-day basis – arguably far outweighing the approach of comparable traditional fund options on the same points.

Not all structured products are virtuous. In fact, I am often among the most vocal in suggesting that a large number of providers and products are sub-standard, often characterised by headline rate, sales and marketing-driven twaddle. But this, unfortunately, is no different to the mutual fund world.

The key for advisers is to ensure that they know how to differentiate and that they do so. There is a plenty of choice available for pragmatic, advisers wanting intelligent, value-adding investment options for their clients.

AGAINST

Kerry Nelson, IFA, Nexus

Having first written about structured products in 2001, I have the strange feeling of groundhog day, in that nothing seems to have changed.

Back then, we were emerging from the aftermath of the bursting of the technology bubble. Interest rates were around 4 per cent and the FTSE 100 had fallen by 16.2 per cent. While I cannot begin to compare the last 18 months in terms of severity and the implications on markets, investor appetite is not that different. In an ideal world, I would have expected lessons to have been learnt by the experiences investors have suffered, in particular, the consequences of significant loss of capital. However, we have proved this is not the case.

The headlines over the past 12 months have reflected the new issues that structured products face and, rather than as we have seen in the past where products have matured in a deflated market, we now are perhaps seeing even more dire consequences in underlying counterparties going bust. Both scenarios have resulted in huge capital losses, so why do we continue to see these as the panacea of the ideal investment solution?

Structured products increased in popularity in the late 1990s, often used as alternative solutions for cash Isas. They were fairly uncomplicated arrangements offering investors participation in the performance of an index, usually the FTSE 100 with 100 per cent capital protection, with the protection being underwritten by the actual bank offering the product. Simple…fairly.

However, then we saw the product wheezes behind the scenes start to become more imaginative in their inventions and the products by nature started moving higher up the risk scale while still being perceived as ideal alternatives to cash. There was an obvious attraction for investors in a relatively volatile market. With benign interest rates, the participation in market returns and the so-called capital protection or “guarantees”, it was as though a wishlist had been written and was ultimately being delivered.

As with any such products other than advice-led, they were flogged to the masses by those ill-equipped to understand the mechanics under the bonnet and the risks involved. They inappropriately became an off-the-shelf offering that clearly required a more thorough process in an advisory environment.

Having been involved in researching this market, I wrote a paper calling for action from Government, regulators and the industry to provide much clearer information to consumers. Needless to say, while the industry response was positive, nothing happened.

I can remember the desperate phone calls at the time, often from the elderly and retired who had lost more than 50 per cent of their nest egg. These were funds they could ill afford to lose and would have no opportunity to replenish. Many were exposed to the more exotic structured products and structures that had a two-for-one loss in a falling market. These investors were at their wits’ end and had received very little comfort from compensation schemes or complaints procedures.

I hoped we would take heed of the negative outcome and change the way in which we offered these solutions. Perhaps we should have been bolder in our actions and only offered such arrangements to the corporate markets. Or at the very least insisted on a more robust process in how these solutions were marketed and offered to investors.

There seems to be a common theme running through manufactured products such as these – just look at what happened with endowments and with-profits policies.

Why do we insist on having to complicate the investment solutions we offer? Let’s stick to a more simplistic and transparent approach and to advice that encompasses the good old-fashioned investment strategies of accessing different asset classes and basing asset allocation on an individual’s requirements.

Within the last 12 months, I have again received phone calls and met up with those who had been advised to take out structured products, only this time they have lost their entire investment as a result of not understanding counterparty risk.

Many banks favoured the mass selling of such arrangements and are again culprits in the issues we are now facing.

What is the answer? I have been so bold as to suggest that these should be removed from the retail market. The best response I received was that I was “a silly girl”. If silly is not losing clients’ capital, then I am very happy with that comment.

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For what it’s worth

As an M&A adviser in the IFA sector I am often asked by chief executives of IFA firms, “What should I do to make my company look attractive to a buyer?” The answer is perhaps best considered in light of how buyers value IFA businesses, as those chief executives who get to grips with buyer valuation are in a good position to consider how best to adjust their business model.

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Comments

There is one comment at the moment, we would love to hear your opinion too.

  1. Can’t see the point..
    …of many of these products, a complexity too far, a price too high for little or no capital guarantee.

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