Should your firm ban structured product advice?

Paul Burgin on whether IFAs can afford to ignore structured products after 2012

Structured products continue to polarise the independent financial advice sector, with detractors wary of potential losses in case of defaults and supporters saying many confuse investment risk and counterparty risk.

The collapse of Keydata, NDF and other providers did nothing to improve the image of structured products. Yet the investments continue to sell in huge quantities.

According to www.srpadviser.com, total structured product sales were £14.4bn last year. So far in 2010, 754 products have been launched and gathered inflows of £9.46bn. Deposits have now taken over from medium-term notes as the most popular products by sales volume.

Most structured deposits sell through branch networks and salesforces. But the advisory share of the market is still considerable. By sales volume, 23% of structured products sold this year were distributed solely by financial advisers.

Advisers who favour structured products are careful to distinguish between good and bad structured products, just as they do between strongly performing unit trusts and those that lag behind. Those that dislike structured ­products also make distinctions.

In a recent edition of its Investment Times magazine, Hargreaves Lansdown restated its long-term dislike of structured products. Danny Cox, head of advice, wrote: ‘Ideally, an investment product should be easy to understand, investors should be able to get their money back at any time and it should offer the potential for healthy returns. Most structured products fail to meet any of these important criteria.’

Mis-selling concerns

Of particular concern is the huge number of bank deposit products that are sold en masse through retail branch networks. Cox thinks few of them represent good value for money. He also worries about advisers mis-selling products to clients.

He says: “There is a huge number sold in SIPPs to clients around retirement age. They are given fixed-term contracts when what they really need is flexibility. Even people in the structured product industry say 85% of them are complete rubbish.”
While structured product literature and counterparty information has improved, Cox still maintains that investors give away too much upside potential to cover capital guarantees.

Cox says: “They give away 70% or more of the potential upside for a five-year capital guarantee. If investors put the money in a FTSE tracker over the same period and included their dividend payments, they would generally get better returns.”

Even so, Cox admits that structured products can play a role in diversified portfolios. ­Hargreaves Lansdown has even sold a structured deposit issue in the past. Cox says the one-off Toisa product gave equity market linked upside when transfers from cash ISAs to equity ISAs were not allowed. Cox says the company is likely to retain its blanket ban on recommending structured products after the introduction of
the RDR.

RDR commission ban

Structured product providers do not believe that advisers will be able to dismiss their products outright and maintain their independent status from 2012. Adrian Neave, managing director of Gilliat Financial Solutions, says: “It will become more difficult to justify a blanket ban. However, a huge number of advisers will keep them off their buy lists in the short term.”

Even if advisers decide to include structured products in their recommendations, Neave believes the RDR commission ban could make the cost of advice unclear for end investors. Until 2012, typical structured product literature includes statements that expenses are unlikely to exceed a certain limit. Neave says: “There are no more charges; it is as transparent as you can get.”

When commission is outlawed, documentation will be altered to reflect new lower maximum charge levels. Neave argues that it may be harder, not easier, to identify the cost of advice for a specific structured product when bought as part of a collection of financial ­products.
He says: “The client will have to pay the inter­mediary, but how do you separate out the advice for a structured product when it has been bought with other funds and investments?”

Bond scandal effects

Ian Lowes, of Lowes Financial Management, thinks too many advisers confuse investment risk with counterparty risk. He says: “The precipice bond scandal polarised adviser thinking about structured products. Some got caught; others simply steered clear. But a handful picked and chose investments carefully.”

Ten years ago, Lowes Financial Management attacked poorly designed products with soft protection that eroded capital three times faster than index falls. Lowes also highlighted the dangers of measuring final performance with lowest intraday performance.

Those products are no longer marketed. Lowes thinks the adviser community should revise its low opinion of such products. He says: “The FSA review that came after Lehman’s showed that there was bad literature and bad advice. But it was not all bad. There are plenty of examples of advisers giving good advice and providers producing good literature.”

Condemning the whole structured product sector for a few bad products would be like abandoning pensions altogether because some were mis-sold, he adds. “Of course, not all investments go to plan. You have to explain to investors that there are risks and they have to be happy with that,” he says.

If reconsidering structured products, Lowes says client and portfolio segmentation can help guide advisers to those products that are best suited for individual customers. He looks at product offers for risk reduction or enhanced returns, or both.

Capital at risk

Capital at risk (CAR) products may carry much more risk to investors’ capital than just concerns about counterparties. Lowes says they still have a place in investor portfolios, provided certain conditions are met and clients fully understand what they are getting into.
Soft barriers should be set at a reasonable rate. Lowes says many products now have a 50% ­barrier that requires the FTSE to half throughout the life of the vehicle before investors start to loose parts of their initial investments. Provided that they understand the risk, investors can benefit from enhanced protection.

CAR products are suitable only when taken in context. Lowes’s chartered financial planners will use them to enhance or protect returns in rising and falling markets alongside a portfolio of funds. In other words, no investor should be placed solely in one structured product, just as they should not be placed in just one single fund.