Jeff Salway: Fears over ‘safe’ investments that may fail to deliver on promises

SALES of ‘structured products’ are soaring but many are riskier than they appear.

They promise cautious investors the best of both worlds, and high-street banks are selling them like the proverbial hot cakes.

Yet while “structured products” are increasingly popular, many independent financial advisers (IFAs) and financial planners refuse to recommend them. They warn that the products – often called “guaranteed equity bonds” or “capital protected plans” – are too opaque and often riskier than they appear.

The City regulator has also voiced concerns over the plans, warning of high potential for mis-selling.

The plans are flying off the shelves, however, with investment houses and banks launching products to entice savers and investors nervous about markets but frustrated by poor cash returns.

“Structured products” is an umbrella term covering a wide range of products which purport to combine potential for investment growth with protection from market losses. The typical product sold by the high-street banks has a term of five years, is linked to the performance of an index or a basket of indices and uses derivatives to reduce or (supposedly) eliminate downside risk.

For example, one recent launch offers income of 5 per cent, provided the money is invested for the full five-year term. The return is dictated by the performance of the FTSE 100, although there’s no direct investment in the index, and investors are expected to get all their capital back.

This isn’t always the case, though. If the FTSE 100 falls by more than 50 per cent over the term, the investor could get less then they invested.

On the face of it, the return is attractive and the risk is low, given that the FTSE 100 is unlikely to fall that far.

But the investor doesn’t know where or how their money is actually being invested, while their capital is also at threat if the counterparty – the provider backing the product – goes bust.

It’s easy to see why the products have proved popular, given the apparently simple premise. Many are worthwhile products, relatively straightforward and deliver on their promise.

The Financial Services Authority (FSA) expressed concerns over the products this year (not long after it had fined Santander £1.5 million for failures relating to the sale of the plans). It warned that “in many cases the benefits and risks of these products are opaque and the potential for mis-selling or mis-buying is high”.

More complaints about structured products are upheld in the individual’s favour by the Financial Ombudsman Service than any other kind of product.

Nine in ten of the complaints to the financial services mediator about “structured capital-at-risk” products last year were successful, compared with around eight in ten grievances concerning payday loans and payment protection insurance.

Many of the complaints were from people who felt they had been mis-sold the products by their bank, particularly where the level of risk had not been adequately explained.

Iain Wishart, of Wishart Wealth Management in Edinburgh, believes that while structured products seek to minimise risk, they rarely do.

“Banks and building societies market them as ‘guaranteed equity bonds’, ‘structured cash Isas’ or ‘protected investment funds’ and have run into trouble with the regulator as many of these plans have failed and/or been mis-sold to their customers,” he said.

Structured products are a handsome revenue stream for the banks, which have seen margins squeezed on overdraft charges and PPI in recent times.

“Banks love these products as they earn on them twice: both the 3 or 4 per cent commission on selling the product and the fat margins they build into the product when they manufacture it,” said Wishart.

One risk that some experts believe is underplayed too much is that of the product counterparty going bust. There are more than 62 issues of structured products on the market, virtually all of which are underpinned by high-street banks.

While bank failure may seem unlikely, Lehmans was big in the structured product market until the collapse of Lehmans Bank, which was the counterparty for the plans.

The risk of counterparty failure is one reason why Tom Munro, director of Tom Munro Financial Solutions in Larbert, is reluctant to recommend structured products to his clients.

“The risk is not only to them but to our businesses as a whole. The collapse of Lehman Brothers in 2008 led to a devastating systematic impact on a sector structured on securities issued by financial institutions, mainly high-street banks,” he said.

Wishart also steers clear. “We don’t recommend them, as they are opaque and rarely can you trust the financial strength of the issuer,” he said. “They make use of derivatives, which adds complexity even for investment experts.”

This is compounded by the fact that not all structured products are covered by the Financial Services Compensation Scheme.

Munro and Wishart are not alone in being reluctant to recommend structured products, but some advisers believe they have a place for cautious investors. The key is to do your due diligence and know what you’re getting into. There are good structured products available, but it’s a case of picking the wheat from the chaff.

For Wishart, it boils down to being realistic and remembering that if it sounds too good to be true, it probably is.

He said: “Risk and return are related: you can’t achieve returns ahead of cash without placing part or all of your capital at risk, while penalties usually apply if you come out early.”

Munro added: “Call me old-fashioned, but terms such as guarantee, protection and FTSE 100 do not belong in the same sentence.”