Structured Products

The term structured products includes a wide range of investments which are designed to provide investors with opportunities for income, capital growth or a combination of both.

Most structured products tend to only be open to new investment for a short period of time. Your money will then usually need to be tied up in the product for a period ranging from between one and ten years. Some structured products offer full capital protection, but others offer only partial or no protection of the money you have invested.

Structured products are complicated investments. You could lose some or all of the money you put in to these products, so make sure you fully understand the risks before investing. You should seek financial advice if you have any doubts or concerns about the potential risks involved with investing in these products.

How do structured products work?
Structured products offer returns based on the performance of the underlying investments within the product. The underlying investments may include exposure to different types of assets such as: shares, currencies or commodities (for example, precious metals).

A typical structured product will have two underlying investment components:

  • a note (a type of debt security). This component is designed to provide capital protection. It may pay interest at a specified rate and interval and will assist in repaying some or all of your original money at maturity; and
  • a derivative (a financial instrument linked to the value of something else, such as a stock market index or the price of another asset, such as gold). This component is designed to provide the potential growth element that you could receive at the end of the term of the product.
Investors in structured products are usually offered a share of any increase in the level of the underlying index or asset price which may occur during the term of the investment.

How is your capital protected?
Even if a product claims to offer investors ‘capital protection’, it is extremely important to bear in mind that structured products can sometimes fail, causing you to lose some or all of your original money.

Structured products broadly offer two types of capital protection:

  • Full - these structured products are often described as offering capital security, 100% capital protection, or a capital guarantee. These products aim to return all of the original money invested at the end of the term, regardless of any fall in the underlying index or asset price. Remember though, that the cost of the provider offering this protection will affect the returns you may receive, and there is still a chance that you could lose some or all of your original money (see credit risk below).
  • Partial - this is often offered by structured capital at risk products (also known as SCARPs). The aim of these products is to return the original money invested at the end of the term, unless the index or asset price to which the product is linked has fallen below a predetermined threshold. If this threshold is breached, it is possible that you could quickly lose some or all of the money you have invested.
Structured products - some of the risks
You could lose some or all of the money that you put in to structured products, so make sure that you fully understand the risks before investing.

A financial adviser, wealth manager or banker who recommends or sells a structured product as an investment must provide you with clear, written information explaining how the product works and detailing the potential risks involved with investing in the product.

The following is a list of some of the main risks that are associated with structured products. The list is not exhaustive and not all of the risks listed may be applicable to different types of structured products:

  • Credit risk - a product may be designed and marketed by a plan manager, but the returns from, and any guarantees that are referred to, are generally provided by a third party. If that third party goes bankrupt, you could lose some or all of your money, even if a product is called ‘protected’ or ‘guaranteed’.
  • Market or investment risk - if the return of your original money depends on the performance of a stock market index or another type of asset, then if the level of that index or the price of that asset falls during the term of the investment you may lose some or all of your original money. If this happens, you could lose your original money very quickly.
  • Liquidity risk - benefits offered (such as capital protection) are usually only available if the product is held for the full term. It may be very difficult (or expensive) to access your money before the end of the investment term.
  • No dividend income - even if a product is linked to the performance of a stock market index, you will most likely not receive any dividend income from the companies which make up that index.
  • Capped returns - many structured products restrict or cap the level of the return you can receive, so if an index or asset price rises above the level of that cap, you will not receive any additional returns.
  • Averaging - the return offered by some products can depend on several measurements of index levels or asset prices during the life of the investment. While this can protect you from short term falls in an index level or asset value, it may also prevent full exposure to any gains.
  • Limited participation - many products only offer a proportion (for example 50%) of any gains made by the index or asset to which they are linked.
  • Inflation - even where a product is marketed as ‘100% capital protected’, the real value of the capital can suffer significant erosion due to the effects of inflation over the term of the investment.
Recent developments
The Lehman Brothers' bankruptcy in 2008 had serious implications for the structured products market in the UK.

Lehman Brothers companies had underwritten or guaranteed several different types of structured products that were developed and sold by banks, wealth management firms and financial advisers. As a result of Lehman Brothers filing for bankruptcy, investors who had put money into these structured products have suffered and many of them will receive very little or no return of the funds that they invested. This highlighted the risks of investing in structured products, even those that claim to offer full protection of your capital.

If you have concerns about a structured product that you have invested in, you should contact the adviser or institution who sold the product to you in the first instance. If you are still unhappy after the firm has investigated the matter and responded to you, you can refer the complaint to a financial services ombudsman or regulatory body.

What about structured deposits?
Some structured products are actually deposits, rather than investments. Structured deposits (sometimes marketed as guaranteed equity bonds) can only be offered by firms such as banks which are able to accept deposits.

With this type of product, the money you invest is treated as if it is held in a restricted access bank account (similar to a fixed term deposit), however unlike a traditional savings account which pays a fixed rate of interest, the interest you receive will depend on the performance of a stock market index or another type of asset.
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