Last year sales of structured retail products reached nearly £9.7bn, a 26% increase over 2007. In all there were nearly 1,000 different plans offered by 97 providers

In the UK, structured retail products (SRPs) first appeared about 20 years ago. These products were investment bond-based, promising a simple ‘x% of the Footsie or your money back’ five year deal. Life companies were the natural starting point for such offerings because they could provide a guarantee (not ‘protection’), but for a variety of mostly tax reasons other wrappers later emerged. By the turn of the century there was a wide range of onshore and offshore SRPs, many of which offered income rather than growth.

The combination of these income plans and the 2000-2003 bear market was a toxic mix which left many investors facing large losses and bankrupted some IFAs. It also prompted the FSA to introduce a new acronym to the financial lexicon: SCARP (structured
capital-at-risk product). The SRP market took some time to recover after the weight of bad publicity: income-based products
have only recently re-emerged.

Last year sales of structured retail products reached nearly £9.7bn, a 26% increase over 2007. In all there were nearly 1,000 different plans offered by 97 providers, according to StructuredRetailProducts.com.

The main features of today’s products are:
Fixed termsMost SRPs have a fixed term, more often than not between five and six years, to meet the eligibility rules for the stocks and shares component of an ISA.

Capital protection The market is now confident enough to offer a number of SRPs – and not just income plans – with less than 100% protection, although the 100% floor remains common.

Formula-based returns Structured products generally have formula-based returns. It is important to understand the formula because with an SRP what you see is what you get.

Complex structures The simple Footsie growth plan is still there, but there are many more complex structures now, with kick outs, accelerated growth, capping and even positive returns for negative market movements

So what factors should be considered when examining a structured product?
Asset class The majority of current SRPs is linked to the performance of the FTSE 100, although it is possible to find a few other asset links, eg a house price index or individual funds. Once calmer conditions return, a wider choice should appear. For example, commodity links and emerging market exposure was available last year. Performance is generally based on pure capital index performance, ie. no account is taken of income. That can make a considerable difference for FTSE 100 plans: the current net dividend yield on the Footsie is 5.75%, which would accumulate to 32% of the original investment over five years.

Soft/Hard protection Hard protection means a fixed level of protection, regardless of asset class performance. With soft protection, the protection falls away if the asset value breaks a given barrier, typically 50% of the initial level.

Counterparty risk SRPs will often involve three parties: a product provider, an out-sourced administrator and a supplier of the underlying derivative-based investment (the counterparty). The counterparty is usually a bank and, if it fails, the SRP could become worthless: SRPs (other than deposits) are protected, not guaranteed. The demise of Lehman Brothers last September brought this issue to the fore. The FSA has recently said it will address ‘the purported regulatory blockages’ that stop advisers knowing the counterparty involved in a particular SRP.

Averaging The formula-based returns of SRPs often use more than just an index reading at the start and end of the product term. For example, in growth plans the final reading may be averaged over six or twelve months. This means last minute crashes (and spikes) are dampened. However, in theory it will also mean more often than not a lower final reading than if there had been no averaging and only an end point value had been taken.

Gearing Some SRPs offer considerable gearing. For instance, it is possible to find plans that offer 10 times the growth in the FTSE 100, albeit with a cap. High gearing normally comes at the cost of soft rather than hard protection, but can be very attractive if market performance is only modestly upwards.

Tax The product format of SRPs is often driven by tax considerations. Most growth products are subject to capital gains tax, although matters get more complicated when there is a 100%+ minimum return. For many investors, wrapping growth products in an ISA is a waste: the capital gains tax annual exemption will suffice. Income products may adopt an offshore company strategy to exploit the rules on overseas dividends.

The current investment climate points to continued growth in the SRP market over 2009. SRPs have the potential to give investors higher than deposit returns with downside protection. However, as history has shown, SRPs are products which need to be understood at outset by the investor. In practice that means the role of the adviser is vital in SRP sales