Many investors are still nervous about putting new money into the stockmarket. Despite last year's recovery, many who invested in equities three or four years ago are still suffering losses - albeit on paper.
Few want to risk losing more but with the stockmarket apparently on an upward path once again, savers who do not invest now could miss out on some good returns over the next few years. One apparent solution to this problem is to buy an investment product which offers gains if the stockmarket rises but little or none of the downside if the market falls – what is called a structured product.
These typically use a combination of deposits and derivatives to achieve their aims. So they are usually on offer for limited sales periods only but many providers bring out new issues as soon as the previous one closes. As well as being available for straightforward investments they can also be bought within ISAs or self-invested personal pension plans.
They are mainly designed as growth investments but income products are also available. They may be linked to a wide range of stockmarkets ranging from National Savings and Investment's Guaranteed Equity Bond, which offers participation in any growth in the FTSE 100 Index, to Dawnay Day's Protected China Fund, which is linked to movements in the Chinese stockmarket as measured by the FTSE Xinhua Index.
Some advisors, such as Justine Fearns, research manager at Chase de Vere, believe structured products have a role to play in diversified portfolios. "They provide investors with a buffer against stockmarket falls," she says. Other advisers believe investors can get better value from conventional investments.
There are two basic types of structured product which typically run for fixed terms of five to six years. One provides full capital security whatever the stockmarket does. The other only provides capital security if the stockmarket behaves in a certain way (for example, if it does not fall by more than 30 per cent over the term).
The latter type are also known as precipice bonds or "Structured Capital at Risk Products" (SCARP). They became particularly popular in the mid- to late 1990s. Many offered high rates of income and the investors who bought into them thought their capital was relatively safe. They were not aware that if the stockmarket fell by more than a given amount, their capital would fall by the same amount or sometimes more if the downside was geared. The steep fall in global stockmarkets between 2000 and 2003 resulted in many investors losing money in these investments. Chase de Vere was one of several firms fined by the Financial Services Authority (FSA) for the way they promoted precipice bonds.
There are still SCARP bonds being sold. They can offer apparently attractive deals. "These bonds may offer, say, three times the rise in the FTSE 100 if the index increases but if the index falls below a certain barrier then an investor will lose part of his capital," Simon Farrant, product research manager at independent financial advisers Towry Law, says. He believes such arrangements are worth considering "providing investors are fully aware of the risks they are running with their capital."
Ms Fearns says Chase de Vere is also still selling these products but not those which use downside gearing.
The fully capital protected products which typically offer participation in the FTSE 100 capped at, say, 70 per cent, tend to have wider appeal. James Dalby, investment manager at advisory firm Bates plc, who feels structured products can offer some "interesting solutions", says, "They are rather like tracker funds but with capital protection." But Mr Farrant points out that one of the drawbacks of structured products compared to trackers is that any gains are based on capital growth in the index only, with no dividends reinvested.
Historically, dividends have accounted for a substantial part of the returns from shares. Another aspect of the products which can work against investors is the averaging in the index that is carried out at the end of the term. Providers argue that this protects investors from a sudden drop in the stockmarket but Mr Farrant has calculated that averaging over a period of longer than six months at tend of the term tends to favour the provider rather than the investor.
Other factors that make it difficult for investors to judge whether they are getting good value for money include the use of several stockmarket indicies to determine any gains or capital protection in a product. A new structured product from HSBC, for example, gives full capital protection but the annual income over the six-year term will be linked to a basket of four stockmarket indicies. It pays a guaranteed 6.8 per cent income in the first year but in each of the following five years the income will depend on the performance of four indicies – the FTSE 100, the S & P 500, the Eurostoxx 50 and the Japanese Nikkei 225. With this combination of indices, ascertaining the likelihood that the future income will be maintained is clearly not that easy.
Another consideration with structured products is the costs involved. They are not explicit but Patrick Connolly, of advisors John Scott & Partners, says there are usually set up charges of around 4 per cent plus commission, which is typically 3 per cent. He says, "We find very few structured products offer good value because of these underlying charges."
When comparing structured products, the impact of taxation also needs to be taken into account. With some products such as those offered by Legal & General, the returns will be taxed as capital gains, with others, such as the National Savings & Investment Guaranteed Equity Bond, treated as income. For investors who can set off their annual capital gains tax exemption against their returns, the former approach may be more attractive.
With any investment product, it is extremely important for investors understand at a detailed level what they are buying. As Mr Farrant says, "If you decide to buy a structured product you must do so with your eyes open and reasonable expectations. There are no free lunches, so don't expect to get big rewards for no risk."
