Structured Financial Products Revisited

Posted on: 28 July 2009 by Gareth Hargreaves

Independent financial advisor Peter McGahan explains why there are risks to be considered before settling for protected financial products.

I made two statements ten years ago on structured products: ‘These investment products are for financial advisers who do not know how to explain investment risk and investment reward to their customers’; I also said I would never write on them again. Well one is still true. This week alone I have had five plans thrown at me to decipher. Three were an easy knock back but here is an explanation of the other two. I have realised now I will be reviewing these every month!!

Firstly these ‘protected’ products are normally marketed by selling to you: ‘In uncertain times like these, the instability of markets leaves investors uneasy’.

That’s a standard opener of the investment literature. Let’s remember one key point: If times were certain and never unstable, markets would rise in a horizontal line and you would never make money as there would never be a cheap point and an expensive point.

Such economic conditions are the opportunity to purchase cheap. Understanding that an investment is not good or bad, but that it is cheap and likely to become more expensive, is the key to making your money grow.

Barclays are hot on these so I will pick out two recent plans. Barclays have a ‘defined’ return plan. There are options for investing for less than five years and I won’t even discuss that seeing as the very basics for investing is for five years. Risk is propelled beyond belief for such arrangements if you are investing for less than five years.

The five year plan refers to 100% protection. There is not a 100% protection. If Barclays fails, there isn’t even the protection of the financial services compensation scheme (FSCS) as the large company rule applies and you could get nothing at all.

In most other investments at least you have the FSCS to rely on to get your original capital back in full or in part. Also the scheme offers 43% return over the five years if the market is up at all.

However it doesn't matter how much it's up by you would only ever receive the maximum 43% back. AAAh!

With these schemes you miss out on the dividends of the FTSE 100. If the dividends were say 3.5% per year that’s 18.8% return over the five years. The market only needs to move 25% for you to hammer the returns these schemes will offer. On March 3rd 2009 the FTSE100 stood at 3512. At the time of writing it is at 4559, a full 29.8% higher. If the market soars you will be limited to just 43% return.

How many people were sold such schemes and are now locked into them with no further upside. In any event you have no protection from the fluctuations in the investment during the plan at all. If you need access to your cash you will receive back what its worth with no protection and no dividends. It is only on the day of maturity that the protection will apply!! What’s the point!

There is also a fixed income plan offering 5% per year for five years. On the face of it, 5% looks quite good, but as with all these arrangements the devil is in the detail. A cash saver is risk averse, i.e. capital security is everything so these arrangements should not be considered in the same league or light as a deposit based investor.

Although Barclay’s literature states this is not a deposit based investment, its one line in a big document and everything else in the document looks like a deposit based investment.

Two key risks to consider: As above, there is no protection under FSCS if Barclays folds and if you try to encash before the maturity date you will receive the value of the investments they are invested into.

Unlike cash your investment will be in medium term notes (debt instruments) such as bonds, and the capital value has very different risks attached to them than cash do.

So there!

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