Structured products offer the prospect of gains but safety of capital. Are they too good to be true?
Wouldn't it be nice if you could reap the benefits of investing in equities while avoiding all the risks?
Of course it would.
Wouldn't it be lovely to defy falling stock markets and rock bottom interest rates, and earn a guaranteed inflation-busting rate on your savings?
Absolutely.
Best of all, wouldn't it be just dandy to do all that with absolutely no risk to your capital?
You bet.
Then surely now is the time to buy structured investment products, that promise to deliver all those agreeable things?
Er, no.
I have a cunning plan
Many investors disagree. Sales of structured products, typically called capital guaranteed plans, have grown 25% over the last 12 months.
The attraction is that they appear to offer a way out of the current maelstrom, by protecting your original investment in full and promising a set minimum return at maturity.
How much you get depends on how an index such as the FTSE 100 or Halifax house price index performs during the term. If it flies, you should outpace the return on any savings account, but if it flops, you have the consolation of getting your money back.
So why am I knocking them?
Pay attention now
Let's take a couple of examples. The Alliance & Leicester Guaranteed Growth Plan has been offering up to 50% of the average growth of the Halifax house price index over 3.5 years.
If house prices rebound, you could be quids in. But if they fall or stay the same, you keep your capital plus a guaranteed 3%.
Alternatively, you can take 50% of any house price growth over 5.5 years, or if there is no growth, a guaranteed 10%.
Alliance and Leicester's Guaranteed Capital Plus is tied to UK stock market performance, paying 10% if the FTSE 100 has risen after 3.5 years -- even by a single point. If it hasn't, you get a guaranteed 1%. Its 5.5 year plan gives you 20% if the FTSE has increased, 1% if it hasn't.
Got all that?
Abbey, which also belongs to the Spanish-owned Santander Group, offers two near-identical plans, while Zurich, MetLife and others also offer structured plans with capital guarantees.
Structural deficiencies
You've probably already spotted some of the drawbacks already. First, given the state of the current housing market, do you think house prices will rise markedly over the next 3.5 years? Or even 5.5 years?
They might, but it is hardly guaranteed.
There is a stronger chance that the FTSE 100 will rise above its current level in 3.5 years, and particularly after 5.5 years.
In fact, it will probably rise much more than the 10% or 20% A&L will give you, so I would much rather invest in the index itself.
Or if you don't want to take the risk, you can get a better return from a market-leading savings account.
Close Brothers currently offers a two-year bond paying a fixed rate of 4.3% a year, while Nationwide offers a five-year bond paying an annual fixed rate of 4.15%. And you don't have to cast a glance at what the FTSE is doing.
Nothing is guaranteed
But my biggest concern is: what is so special about 3.5 or 5.5 years? Nobody can predict where house price or stock markets will stand on any specific future date, but that's what you are being asked to do.
I have a real problem with investments that must leap a set (and random) hurdle on a particular date. There are just too many variables.
If you invest in, say, a FTSE 100 tracker over the long term, you don't have to worry where the index stands on any particular date. You can decide when the time is right to sell up and cash in, rather than your plan manager.
The price isn't right
Structured products fail a host of other tests as well. Their charges are buried in the manager's performance calculations, so you have no idea what you are paying. But it won't be peanuts, because these plans have a lot of mouths to feed: the bank offering the plan, the company stumping up the capital guarantee, and the adviser who sells it.
Some plans also have a nasty sting in the tail. They are backed by a complex tangle of financial companies, sometimes based overseas, which means investors can unwittingly sacrifice their protection under the Financial Services Compensation Scheme (FSCS).
UK investors in the NDFA Capital Secure Fixed Rate Plan, which offered up to 45% over five years, were shocked to discover it was underpinned by Lehman Brothers.
NDFA is regulated by the FSA, but Lehmans was based overseas, which meant investors weren't covered by the FSCS. Their capital guarantee was worthless, and they are now standing in line with other Lehmans' creditors. They could wait more than a decade for compensation, if they get anything.
Given that this type of plan is often sold to retired people, many will be dead before the case is resolved.
A capital idea
Capital guaranteed products appear to offer you the best of both worlds, but all too often you get the worst.
A better bet is to build a balanced portfolio of equities, corporate bonds, cash and property, and hold it for as long as you think is right.
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