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To herald structured products as 'win-win' for clients except in the most extreme market conditions is highly misleading, Worldwide Financial Planning's Peter McGahan says.
Perhaps the single biggest question I am asked about is structured investment products and they bore me senseless.
These are the products you will see listed in bank windows or sold over the phone or by direct mailers.
They are sold as protecting the downside of client's money with an element of return on the upside and are, in most cases that I see, sold to risk averse investors as a reasonably simple and straightforward investment.
However, these structured products (often murmured or muttered as guaranteed) are singularly the most complicated investment you could consider for your capital.
I really couldn't imagine why so many of these products were being designed but, when you look at the profit they make for the banks, for a quick sale it's a little easier to understand.
I am hoping to never have to answer a question in relation to these plans again and, at the same time, explode the sales lure of ‘you can have the return with no risk'. Structured products are so complicated; I will cover them over a number of columns.
The whole ‘structured product sale' starts with a poor communication in relation to risk.
Many customers are asked embarrassingly non-specific questions about risk, such as ‘what risk rating are you from 1-10?', or ‘here is a pyramid with cash/building society at the bottom and high risk Japanese warrants at the top, which risk are you?'.
Invariably, when you are asked a stupid question your answer will have to be of the same quality and it is this poor questioning around risk that has lead tens of thousands of customers (particularly of banks) to buy such poor quality contracts.
Few financial advisers really want to explain risk as they fear the customer may not want to invest at all so they skim over risk and reward.
It is from this starting point of poor questioning that investors follow on the trail of structured contracts believing them to be a 'win-win solution' where you can only lose in ‘extreme' situations but can gain all round. This is highly misleading.
A structured contract is a plan that is prepared by a product provider and more specifically for the product provider.
Unlike a normal investment, where shares or property are acquired directly, these arrangements tend to buy a range of complex instruments to achieve their objectives. Clients would not begin to understand not only how complicated they are, but also how difficult they are to stress-test against market downturns.
For example, they may offer 80% of the return of the FTSE All Share index as long as the FTSE All Share doesn't fall by more than 50% and not recover.
In order to achieve this, the company buys a ‘promise' from a provider (counterparty) such as RBS, Lloyds etc which provides an annual return, which in turn provides the capital protection at maturity.
In simple terms, if the annual return (promise) was 6%, the provider of the structured product might have to place c75% of the original investment with the counterparty and that would provide the 100% capital return after the five years. The remaining 25% will go towards a mixture of charges and the purchase of complex derivatives in the stock market. It is this 25% which provides the 80% upside participation in the FTSE100 as above.
Investors in structured products often do not realise they are missing out on the dividends of the FTSE 100 and also that if the counterparty fails they may lose everything.
Peter McGahan, Independent Financial Adviser
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Re Structured Products
They are certainly complicated internally but that doesn't mean they should be dismissed. Provided you are satisfied with terms offered and the counterparty providing the protection, they can have a place in a person's portfolio. I treat them as a separate asset class, often structured to have one mature each year. The loss of the yield on the underlying index is well known and should be pointed out to the client, but since they are not investing directly in the index this isn't really a negative - the terms of the plan are the thing to concentrate on. Treat them on their merits. There are plenty of decent ones around, but I have to agree there are plenty of dogs, particularly from the high street banks. Independent Advice is essential.
Posted by: Tony Devine
An outrageous con by banks
1.They make up complicated formulas that when scrutinized are nonsense. 2.Sell this to some poor gullible as protected, guaranteed, win win by some smart suits. 3.Buy a fixed deposit for the lock-in period. 4.Give the poor gullible his money back at 'maturity' with a glossy bit of BS on how lucky he was that he did not lose and what a favor they did him. 5.Share out the fixed deposit interest as commission and bank profit. 6.All for zero money down.
Posted by: CJ_51
Structured Products
These products are rarely suitable for the retail investor and most certainly not for the risk averse investor. The banks and building societies deserve all they get for selling these products to anyone they can with little regard for the suitability. I wonder how many of thh bank advisers actually know what's going on in these things. In my opinion these products are mainly expensive drivel and should be banned from the retail market immediatly.
Posted by: jonnieb666
Too Simplistic
I disagree. The view is too simplistic. Every investment should be considered on the potential returns versus the risk involved. Some structured products offer much greater value than other 'traditional' investments and can produce pay off profiles which are not achievable by other investments.The underlying costs are also often less than the charges levied by funds and other investment vehicles. As with everything they shouldn't be used in entirety but then they shouldn't be excluded in entirety either. They have a place where understood and evaluated by a professional adviser who understands the animal.
Posted by: wilmot
Oh dear...
What a horrible, ill-researched and dogmatic article. There is nothing at all wrong with structured investments - if they are used properly. I have no issues with the criticism of bancassurance. I have no doubt whatsoever that millions of pounds of retail investors' capital are invested into mis-sold structures every month. However, that is a criticism of the banks' "advice" process, not the structured investment market as a whole. Structured investments do not remove risk from an investment, nor should they profess to. Some advisers may make this claim, either though ignorance or malleable ethics, but once again that is a criticism of the advice process and not the product. What structured investments can do is reduce or remove market risk, but at the expense of adding or increasing counterparty risk. This is not necessarily a reduction in risk overall, but it is a form of diversification. It is a trade-off, and as part of a well structured portfolio can be used to manage risk without overly sacrificing returns. To say that "the whole ‘structured product sale' starts with a poor communication in relation to risk" is a fairly damning generalisation. To properly use a structured investment it can only follow a comprehensive conversation about risk. I agree that picking a number from one-to-ten does not even begin to approach a risk analysis. However, to talk only about exposure to market risk is an equally poor approach. Again, to state that "few financial advisers really want to explain risk as they fear the customer may not want to invest at all so they skim over risk and reward" is a very bold statement. I can assure you that you do not speak for me, nor any of the advisers I am proud to work with. To make a comment such as "a structured contract is a plan that is prepared by a product provider and more specifically for the product provider" proves only one thing - the commentator does not understand structured investments. It is unfortunate that such a degree of unfounded scepticism exists right across the UK financial advice sector. Not all structured investments are good, by the way. Some are shocking. Some do offer unbelievably poor terms, and are so heavily weighted in favour of the provider it beggars belief. Please do not think I am a carte blanche supporter of structures in all their forms. That being said, I recommend far more mutual funds (be it unit trusts, life funds, pension funds…) than anything else, but I would be the first to say that more than 50% of those are shocking. I am, however, a carte blanche supporter of quality financial advice. In terms of structures being too complex for the average retail investor to understand, are they really? I own a car. I know how to drive it. I know what I need to do to maintain it. I know all the risks involved in using it. I know all the benefits involved. I have no idea what goes on under the bonnet, nor do I desire to. Any client that has ever invested in a structured investment on my advice knows everything they need to about their investment. They know all of the risks involved. They know all of the potential benefits. They understand the tax position. They understand all of the features of the product, including how the charges will affect them. They know who the counterparty is, and all the implications of the counterparty defaulting. They probably have no idea what is going on under the bonnet of their investment. I do not start a conversation about a structured investment with a master-class in put and call options and credit default swaps; not do I feel I should; nor would anyone expect me to. I do, however, have a comprehensive file showing extensive due diligence regarding the workings of the product, the level of counterparty risk et al. That is my role as an independent financial adviser. To do all the research, wade through the pages of technical jargon and make sense of it all, make an appropriate recommendation and communicate it to my client in a way they can understand. I believe it to be inevitable that structured investments will take an increasingly central role in retail investment advice. I also believe that this should be a good thing. However, this sooner people stop writing silly, uninformed articles like this the sooner we can start to sort the wheat from the chaff and demand the sort of innovation that will actually improve our clients’ financial lives.
Posted by: South-West IFA
As clear as mud - for a reason
"A structured contract is a plan that is prepared by a product provider and more specifically for the product provider." You got it!
Posted by: John Whipple
Structured Products
It's seems that poor Structured Products have fooled as many advisers as investors. Also, aren't with profits funds just another type of structured product?
Posted by: Mark
Simple Analysis
Overall, a poor article being sensationalist and lazy rather than informative. As with any product, there are good and bad SPs. I have a simple approach when evaluating them which starts with explaining to a potential investor how they are paying for the guarantee, typically with the dividends forgone. Often these may amount to roughly the safety level offered by the SP. I then point out that *IF* they are purely interested in securty they should compare the accumulated interest of a deposit account with the minimum guaranteed / target return of the SP. Obviously this is not the whole story but if the client has understood the foregoing then we can consider whether a particular SP might be suitable. Only a tiny proportion of SPs pass muster but the good ones have done what was expected and my clients were happy, which is the aim of the advice.
Posted by: Michael Both
? confused
These forums are always more than amusing. McGahan has made straight forward valid points that either need to be challenged with straight forward points or agreed with. Instead Mr Southwest IFA (peculiar name)who I assume doesnt want his name mentioned because he sells these appalling products to his customers hasnt challenged his points nor has the last writer. The article is highly accurate and has clear points which both the aforementioned have failed to deal with. Deal with things logically gentlemen rather than emotionally. Yes he might have rumbled your sales feathers with his direct honest approach but there is no malice, so, defend with logic as to why you believe the points are wrong. Adult like and commercial like would be good. But I suspect thats the problem - You cannot defend your sales.
Posted by: Transparent is everything
I'm sorry?
Dear Sir/Madam, I am seriously struggling to work out what on earth you are talking about. I have just re-read this artcile, and am struggling to find the logical points I am supposed to refute. The article makes a number of unsubstantiated generalisations, namely to imply that all structured products are bad, to state that "few financial advisers really want to explain risk" and "a structured contract is a plan that is prepared by a product provider and more specifically for the product provider". Each of these comments is, relative to my unserstanding of structured investments, nonsense. It is difficult to make a sensible response to something that in itself makes no sense. I certainly feel no urge to 'defend' anything. I do not 'sell products' to 'customers', but I occasionally use structured products in my advice - and do so with pride. I have recommended them to close friends and family members, and I am resolutely confident in my advice. Having re-read my initial comment I cannot see that it is anything other than balanced, logical and wholly unemotional. There are many points in the main article I agree with: * Structured products should not be sold as being 'guaranteed'; they carry risk. * Many bancassurers do 'flog products' indescriminately; this is wrong. * Some structured investments offer poor value. * The inner-workings of many structured investments are complicated. * The dissection of the example investment is fair. However, the example used is not, in my opinion, a fair representation of the entire structured investment market. None of these facts should lead an adviser to write off an entire range of investment strategies. As for your comments regarding the use of a pseudonym when posting comments to strangers in a public forum, I am not even going to address your remarks other than to say we are not in a primary school playground, Mr "Transparent is everything".
Posted by: South-West IFA
? eh?
Southwest IFA structured products salesman defends his sales of structured products by typing lots of nonsense. What are you talking about. The article is clear and specific and is as mr Transparent says on the mark. You are only bothered because you are selling these products and need to substantiate them. Go and work in a derivatives house for a few months and you will then understand how these plans work and how they rip customers off. they are built from the top down, not bottom up. Your naivety with these products is quite shocking.
Posted by: colin theobald
.
I have come to realise that this is not the correct forum for intelligent discussion around these matters, and debate in fact reduces to little more than name calling, unfounded accusation and unwarranted hyperbole all too quickly. For that reason I am going to respectfully bow out at this juncture, leaving any who choose to read the above to draw their own conclusions. I am sure if I returned to this page subsequently I would find myself profoundly criticised, with any number of aspersions cast over the reason for my withdrawal and links made to the quality of my advice to clients. Please be aware that I have only made the decision not to respond as it feels futile, and I can better use my time elsewhere.
Posted by: South-West IFA
...
Clearly you have no experience as a financial adviser to make such statements, I think you should go work for a real institution in the City of London not in the City of Cornwall for yourself claiming to be an expert or specialist in any form of Investment Advisory. I have been a very happy investor for the past 5 years in Structured Products working with top banks in London and Switzerland in all types of top structures in reverse convertibles, capital protected notes and COSI's (collaterized Secured investments) that are backed by collateral and therefore safeguard investors against issuer default
Posted by: Christian Deliusi
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OK you've sussed it! But let's be more blunt - the more 'secure/guaranteed' the contract the more complex it tends to be for obvious reasons. The ONLY winners are the involved parties. Just looking at the number of these in many contracts makes one wince at the thought of the dimension of opaque costs. Despite researching (even Keydata!) and hearing the blandishments of the FSA I have never recommended these products. Clients have asked me to buy them and to date nobody has made a profit over the average spread portfolio returns that we have managed to achieve. I will need a lot of convincing to even consider them in future.
Posted by: Andrew Moore