Often criticised as inflexible or of limited use Mark Owen, Sales Director at Keydata explains why structured products provide solutions for investors needs across all ages time horizon and relevant examples of their use in a portfolio…

The term structured product is a cover all term for an investment specially created to provide an investment solution that cannot be met from the standardised or traditional investments.

Typically, they are a pre-packaged investment strategy, based on derivatives or other alternative assets that offers partial or full protection of invested capital if held to maturity. The benefits of such products include principal protection, tax-efficiency, enhanced returns within an investment and reduced volatility within an investment.

Whilst structured products have been used by discretionary advisers and private banks for many years they became established as retail investments during the three year bear market following 2001. In an environment of low interest rates, low yields from bonds and increasing volatility from equities, investors knew they needed to invest but would only proceed with a degree of capital protection to avoid the losses they were enduring with traditional long only actively managed funds.

Structured product providers are some of the most innovative companies in financial services packaging numerous kinds of alternative assets into simple to understand products that give retail investors a clearly defined upside and within risk parameters that are accessible. In other words the terms of the bet are easy for investors to understand. This is a clear advantage over traditionally managed open ended funds where investment strategies are often defined in terms of correlation with a benchmark.

Such variety within a fairly basic formula means that structured products are highly versatile products that can fit within literally every investor’s portfolio regardless of age, time horizon or income or growth requirements. The problem structured products face is not from their structure but from a nervousness caused by the rogue companies involved in the precipice bond debacle. Now that the majority of these companies have either gone out of business or ‘changed focus’ the structured product market has a real opportunity to demonstrate the value of buying them.

Misconceptions remain, but my company is committed to structured products and still works closely with advisers that can understand alternative investments to deliver investment returns for their clients that long only actively managed funds simply cannot do. The following examples are generated from feedback case studies that we encounter through our continual dialogue with the intermediary community and demonstrate why structured products should be one of the cornerstones of modern asset allocation for retail investors.

Defined Terms – Time to Plan

A structured product is designed to be held until maturity, normally over a five year term. The fixed term is an anathema to the annual review of a portfolio to chase performance but is a feature enjoyed by investors because it provides diversification over their assets. All investors understand that there is no advantage to putting all of your eggs in the same basket so it is correct asset allocation to vary the strategy of your investments – if it is an established practice for professional institutions to allocate to alternative assets why are only retail investors better off with a cash and equities only portfolio?

In a balanced portfolio it makes perfect sense to allocate assets to buy termed investments since it allows more time to concentrate on the whether the claims made by active fund managers can translate into performance.

For example any income investor is likely to hold fixed interest deposits equity income funds (normally UK) and some corporate bond funds. A structured product offering a fixed coupon fits a portfolio such as this perfectly since it offers defined risk and returns. Assembling a series of structured income products therefore creates a reliability of income that investors strive for and when more than one product is owned sequential product maturities that can either be rolled over into another product or moved to other products. As a product provider with over 20 income products where coupons are being paid and not a single product is currently ‘underwater’ we know this process works and that deposit plus returns over a finite period without the capital risk of traditional funds
are attractive.

Flexibility

Structured products can automatically accelerate growth from equity markets, something that many tracker funds and active managers would love to do, but can’t. Dividend income is not included in returns but the following example of how flexible a structured product can demonstrate how advantageous automatically gearing growth can be.

A structured product held by a SIPP offers double the returns of the FTSE™ 100 Index over a five year term with growth capped at 80% of original capital, with full capital protection unless the Index falls by more than 40% over the term. Originally bought in 2003 the product has created a 40% increase in value 3 years into the 5 year term. Instead of waiting maturity the product is cashed early and rolled into a near identical product – resetting the starting level for geared returns on 140% of the original capital invested (the capital protection level is also based on the new starting price, which increases the level of risk since the Index would have to fall from its new starting level for capital to be at risk).

This acceleration in a pension fund is an excellent example of how structured products can flexible returns before the planned maturity if it is the right time to crystallise paper gains into cash and still hedges against market falls with the capital protection formula.

Geographic and Asset Diversification

With a structured product an investor can buy access to domestic, European, Japanese equities or even commodities with either full or partial capital protection providing genuine diversification at a low entry level of investment. It has long been recognised that UK based investors buy too many UK based investments. Whilst many acknowledge the need to purchase ‘foreign’ investments frequently investors are put off through fear of investing in markets they do not really understand and therefore buy what they know.

Due to their simplicity and clarity of risk structured products can provide much needed asset portfolio diversification with clearly defined risk and reward parameters and also much needed finite investment period. Since the diversification is ‘packaged’ investors can engage more fully with the macro factors over the advantages of diversification without the more esoteric demands placed on them when buying long only funds with individual active strategies.

Whole of Life Investments

Its often said that there are three distinct phases to an individuals demands on money during their life: accumulation during your maximum earning power, utilisation as children are brought up and earnings flatten off and finally preservation of capital during retirement. In each of these stages of life a structured product can provide a solution to the needs of an investor. What is forgotten is that most investors simply want their investments to do what is claimed on the cover on the brochure. Delivery is the single most important requirement of an investor and is what keeps them happy. Structured products deliver and that makes investors and clients happy. Chasing alpha is all very well, but most clients want a product that they understand and makes them more money than they could create with the cash on deposit. Structured products deliver and provide the clarity of investment terms that investors like and can therefore fit into any portfolio. My Company exists because of that and is happy to continue to create investments that deliver what we claim they will.

Mark Owen
Sales Director, Keydata Investment Services