As interest rates remain at an all-time low and markets continue their roller-coaster ride, it’s not surprising that savers have been tempted by structured products, also known as stock market-linked bonds.
These investments typically offer returns of about 8 per cent per annum over a fixed period of five or six years and are linked to the movement in a specific stock market index. For example, the return may be payable provided a particular index does not fall by more than 50 per cent over five years. Although annual sales have fallen sharply from £13 billion in 2009, people are still putting about £3 billion into these products each year (£40 billion in total).
However, the promoters of structured products often struggle to explain how they achieve such juicy returns. What’s more, some products have failed to deliver on promised returns.
In the credit crunch of 2008, Lehman Brothers, the guarantor underpinning a number of products, went bust, leaving many of the 6,000 investors with nothing. Since 2008-09, the industry has undergone a major clean-up, says Chris Taylor, of Lowes Structured Investment Centre, a company which has marketed the products for many years.
However, Roddy Kohn, of Kohn Cougar, the independent financial adviser, says structured products still carry risk and investors should always ask the following questions:
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Who is providing the return?
Kohn says: “You need to ensure that the company is financially strong. If the company that is supporting the structure collapses, you may then have no recourse to the Financial Services Compensation Scheme, unless you can prove mis-selling.”
Are you happy to tie up your money for four or five years?
Kohn points out that these investments can sometimes make it difficult, if not impossible, for you to withdraw your money before the allotted time.
You should also remember that an index, or a particular share, may only have to dip below the set cut-off level once to deprive you of your promised return.
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Have you considered tax?
The return from your structured product could be liable for either income tax or capital gains tax.
Kohn says: “The Meteor four-year FTSE four-monthly income plan is offering a headline rate of 7.32 per cent per annum, but this is before tax. “If you held this investment outside a tax wrapper, then the figure would fall to 5.86 per cent for a basic-rate taxpayer, 4.39 per cent for a higher-rate taxpayer and 4.03 per cent for a top-rate taxpayer.”
Taylor points out that you can cut your tax liability by putting your investment into an Isa or a Sipp.
How can these products deliver returns as high as 8 per cent?
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Zak de Mariveles, the chairman of the UK Structured Products Association, says recent returns have been high, in part because stock markets have generally performed well.
“You are taking some risk, that the financial group that is responsible for delivering the promised return might default, and part of the relatively high return is your compensation for that risk.”
Taylor says: “Most structured products in the UK are now used almost exclusively by independent financial advisers, as opposed to being sold by high street banks and building societies. As a result, the industry today is smaller but with better quality products.
“Analysis of the 1,000 capital at risk structured products to mature most recently shows average annual returns of 8.29 per cent. Only 40 of the 1,000 products matured with a loss.”
However as recently as March this year the Financial Conduct Authority, the chief City regulator, raised concerns about the structured products market. It said that consumers found it difficult to assess whether they were getting a good deal and tended to overestimate the size and likelihood of a possible return. It also concluded that companies needed to do more to ensure the products had a reasonable prospect of delivering value.
Mr Kohn says: “Structured products might be suitable for a small proportion of very sophisticated investors but the only way to be sure is to get advice.”