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Structured success is built on solid foundations

2008 was the year in which “protected investments” – as I believe structured products have earned the right to be called – stepped out of the shadow of the conventional fund market and became mainstream investments in their own right.

Sales hit record highs and show every sign of continuing on an upward trajectory, indeed, I understand that around £2bn has already been invested in protected investments this year.

Clearly, unprecedented market turbulence has been a key driver behind the boom. In this respect, it is regrettable that many investors acted too late to arrest the precipitous decline in the value of their portfolios last year.

But better late than never – the ongoing success of the sector clearly suggests that cautious investors have realised that moving from cash to equities is, in terms of risk, possibly too great a leap.

Protected investments are the natural bridge between the two extremes and I believe capital-protected structures have in the past year usurped cash as the logical entry point into riskier investments such as funds.

This is not to say that the protected investment market can now sit back and declare, Caesar-like, that it came, saw and conquered.

On the contrary, the relatively lofty perch on which we currently sit can easily be toppled. In order to consolidate our position and ultimately to compete with the conventional fund market – providers must recognise how conventional funds achieved their ongoing dominance.

In terms of visibility, performance, ease of dealing, connectivity into platforms, collateral support and so on, there is no doubt that protected investments, on the whole, lag their open-ended counterparts. There is much to improve.

Does this mean that protected investments will revert to their former position at the margin of portfolios as soon as there is a sustained market rally?

There is a strong argument to suggest not. Broadly speaking, the sector is enjoying record sales for two main reasons – one, because long-time supporters of protected investments are using them more than ever, and two, because advisers who previously only used unprotected equities have begun recommending structures. In fact, we are regularly conducting business with more than 1,000 IFA firms – a big hike on this time last year.

I doubt that level of support will evaporate at the first sign of a market rally, simply because investors have been bitten once and will be reluctant to repeat the experience and, crucially, advisers have become far more accustomed to using protected investments and therefore have a much better grasp of how they can be used in tax planning and portfolio construction.

With investors pouring into protected investments, it is interesting to note which types of structure are enjoying the biggest inflows. Contrary to certain expectations, this varies according to market conditions, in the same way it does in the conventional fund sector.

The current trend, which gathered pace in the second half of 2008, is towards fixed- rate returns, either with full or partial capital protection.

In some ways, this is unsurprising. Advisers are not currently overwhelmed with choice when seeking attractive returns in an environment where cash rates are negligible and the stockmarket continues to head in no particular direction, having fallen by around 30 per cent in the past 12 months.

But I believe there are other reasons. First, there is a high “hygiene factor” with these investments – a reassuring lack of smoke and mirrors. Second, they are very simple, something that has clearly appealed to investors who have probably been shocked by the poor performance of their unprotected investments and naturally gravitated towards structures offering greater certainty, both in terms of return and capital preservation.

Finally, these products, particularly the capital at risk issues with early maturity options, have, in recent times, offered some very attractive rates.

This has caused a certain degree of unease among a few advisers, as the gap between UK base rates and these products’ returns is so large that it has been suggested to me that they must be too good to be true.

To an extent, I understand the sentiment but it is misguided. High payoffs are simply a function of market volatility. Investors are, in the current market, just seeing a lot of value for accepting a degree of risk to their capital. Rates will not stay at this elevated level forever, they will come down in line with market volatility. Financial trickery is not a factor here.

Capital-at-risk investments have always attracted a degree of suspicion, of course. Many advisers say their disapproval stems from a lingering fear that a big chunk of their clients’ capital could disappear in a puff of smoke should the index plunge before a product matures.

Notwithstanding the mitigation that averaging provides against this, the argument seems to me to look at the proposition from the wrong end of the risk spectrum. Investors, although more risk-averse, still want exposure to equity performance. Protected investments offer this equity exposure but with an element of protection more commensurate with a lower tolerance to risk.

That is why protected investments are enjoying such strong demand at the moment and why I believe they will continue to do so in the coming months and years.

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