Many banks have now started offering retail investors an apparent solution to choppy markets in the form of structured products. These claim to offer the best of both worlds – the benefits of stockmarket or commodity investing without the risks. There are already a large number available, with 56 listed on the London Stock Exchange alone, linked to assets ranging from commodities to equities and even housing.
Most fall into one of four groups: trackers, geared (or leveraged) return trackers, income-based, and specified minimum or maximum return. So what are they and should you invest in them?
Structured products: the trackers
MoneyWeek regulars will be familiar with standard exchange-traded funds (ETFs) that replicate the return on an underlying index, sector or commodity. As the FTSE 100 rises or falls, so does a product such as the iShares FTSE 100 ETF (LSE:ISF).
However, two other types of ETF are now available – inverse and geared. An inverse tracker, such as the ProShares Short S&P 500 (AMEX:SH), offers a share denominated in dollars, which rises as the S&P 500 index falls and vice versa. A geared, or leveraged, tracker, such as the ETF Securities’ Leveraged Gold (LSE:LBUL), meanwhile, offers twice the daily change in the Dow Jones gold sub-index.
Combine these two features and you get products for very bearish investors, such as the ProShares Ultrashort S&P 500 (AMEX:SDS), which rises by twice the daily fall in the S&P 500. While the leveraged options are not for the faint-hearted, we like ETFs generally because they’re quite simple to understand and cheap – unlike some other structured products.
Structured products: income products
These try to tempt you by offering a high fixed income for a set period. A typical example is the Barclays Income Investment Note, a five-year plan that pays quarterly income equal to 7% a year, provided the FTSE 100 is at, or above, its starting level at maturity. If the FTSE falls by more than 40% at any point, your capital will be reduced by 1% for every 1% the FTSE falls below that level.
If you prefer not to put your initial capital at risk, Lehman offers an Enhanced Return Plan with a fixed 22% return (just under 7% per year) paid after three years; or 50% (just over 8%) paid after five, provided the FTSE is no lower than its starting point by the end of the term. Otherwise, you just get your initial investment back.
These are billed as “win-wins” for a nervous investor – but are they? The headline interest rates look competitive, but you can earn more than 6% from an online bank account and even more with national savings bank certificates without risking your income or capital.
More exotic still, Meteor Asset Management recently launched a five-year Solar Income Plan offering a juicy fixed income of 10%. Sounds good so far. But your capital is only returned in full provided four out of their chosen five UK banks do not suffer share price declines of more than 50% by 2 May 2013. If this condition is breached, you lose capital 1:1 according to the worst performer.
But who does this really help? As a UK banking stock bear, I don’t want any of my capital tied, for five years, to the share-price performance of just five banks. As for banking bulls, shares in Meteor’s chosen quintet of Barclays, HBoS, HSBC, LloydsTSB and RBS already offer yields of up to 10%, plus potential for capital gains on top should share prices recover. So you could just buy them instead.
Structured products: maximum return products
These products tend to offer investors a share of the gains in an underlying index. Barclays sells a five-year product that offers a one-off return of 75% of the amount invested, provided the FTSE 100 is equal to, or higher than, the initial level when the plan starts. Should the index fall by more than 40% you lose capital on a one-for-one basis. There are many products like this around.
The chunky headline numbers often make these products sound like a good deal, but they are not. The fixed term – two to seven years is typical – leaves you with little flexibility to move your money without either losing benefits or incurring penalties. And despite being linked to the performance of the FTSE 100, these plans don’t pay a penny in dividends, which Morningstar estimates contributed 30% of the five-year FTSE 100 return through to December 2007.
And the 75% return from the Barclays product implies you lose 25% of any rise in the FTSE too. Should the FTSE fall sharply meanwhile, you risk both your capital and the interest you could have earned elsewhere – on £1,000, for example, just a 5% gross return a year over five years compounds up to £276.
Worse, the loss of this interest is almost guaranteed on some of the structured notes on offer, whose performance is linked to previously white-hot markets such as Chinese equities or soft commodities, which are currently cooling.
Ultimately, if you believe a market is set to rise, then buy an ETF and get full, cheap exposure to the gain. If you are worried about your capital, then we still believe you’d be better off in a safe, interest-paying cash account.