Behavioural finance has an increasingly central part in conversations about investment risk, since managing emotional responses plays a key role in maximising returns.
Structured products are investments which aim to deliver a pre-defined return over a set time period, provided certain criteria have been met.
Such as the underlying asset performing within certain parameters; you will typically find structured products stipulating that a reference market index cannot fall below a certain level. When they began, structured products could only be sold to sophisticated institutional investors like pension funds, but they have evolved over time to reach the wider retail market. They are now distributed by private banks, investment managers and independent financial advisers quite widely.
There are many types of structured products offered by wealth managers and these can be based on a wide range of investment classes, including: equities, market indices, bonds, foreign exchange, commodities, interest rates and sometimes even more exotic items.
The purpose of a structured product is to condense a continuous range of real world outcomes – like the rise and fall of the FTSE 100 over time – into a structured return. A simple example of a structured product might look something like the following example.
A 5-year structured product is linked to the FTSE 100. When you invest in that product you are essentially making a bet that in five years’ time the FTSE 100 Index will be higher than its current level. If at the end of the product’s life (and perhaps at certain reference points during the product’s lifetime) the index hasn’t fallen below its starting level then an investor might get back 100% of their initial investment plus an additional 30% return on top.
If the FTSE 100 has fallen, however, then the investor might stand to lose capital on a one-to-one basis with the index. Many structured products offer graded returns according to the performance of the asset, including both upside and downside risk. This means that structured products are a good way to gain exposure to an asset class or market while controlling for risk quite robustly; you can be quite specific as to the parameters. You can also choose from a variety of currencies, maturity dates and underlying assets which means that your wealth manager might be able to get a lot of strategic advantages out of using structured products as part of a sophisticated overall investment strategy. Structured products can even offer tax advantages for some investors, as they are typically subject to capital gains tax rather than income tax on returns.
Investors may well be attracted to structured products by the apparent transparency of the payoff they offer, but under the bonnet these products are highly complicated. They are therefore subject to complex regulation and should not be entered into lightly.
The financial crisis underscored how risky structured products can be. Ensure you read the fact sheet carefully before you invest, and that you fully understand all of the risks these investment products entail. Your wealth manager will be adept at illustrating the true risk and return characteristics of any investment products you are contemplating and the impact they will have on your portfolio overall.
You should also bear in mind that even in the best scenario, structured product fees can be expensive. Check the fees involved in buying and selling before making an investment. You may also find that – because of economies of scale – it is a lot more cost-effective to invest in structured products through a wealth manager, rather than through a DIY platform. Transaction fees are always a big drag on overall investment returns and you should minimise them wherever you can.
You should discuss the details with your wealth manager and review all product documentation; if you are not entirely comfortable with the associated risks then these investments might not be right for you.
If you haven’t considered using a wealth manager before – or if you haven’t reviewed your existing manager to check their competitiveness and suitability try our smart online tool. Or, if you would like to discuss your situation with our straight-talking team, please do get in touch here.