Structured products: risk vs. reward

Alamy

With many investors put off the stockmarket amid the current choppy waters, there is one product tempting punters with claims to offer returns even when markets fall.

Structured products give the potential to triple the best cash savings rates available on the highstreet, but just what risk do these returns come with?


Structured products offer returns based on the performance of underlying investments. Many products are linked to a stockmarket index such as the FTSE 100 or a "basket" of shares.

There are generally two types of product, one offers income, the other growth, and investors have to commit their capital for the full term, usually three or five years. The investment is not guaranteed and if the index or basket of shares does not perform as expected over the term the investor might not get back all their capital.

Fans of structured products say they give investors equity exposure without having to endure the rollercoaster volatility of the stock market, yet critics say they are designed to tempt with headline rates that can cause investors to overlook the downsides.

Tempting terms
Morgan Stanley launched a variable return structured product this week that gives investors a 60% return after six years even if the FTSE100 loses 20% of its value over the period. The Morgan Stanley FTSE Booster product promises to return twice the level of the FTSE100 over the six-year term, with upside capped at 60%.

The fixed returns on offer from structured products also seem tempting. Barclays Capital's FTSE100 Autocall product pays 12.5% a year. Autocall products are also called "kick-out" products because they wind up the first time you meet the product's criteria. So if the FTSE is at or above its starting level on the first anniversary of the product, your money is returned, plus a 12.5% return. If it is not, but is on the second anniversary, your money is returned plus 25%, and so on.

Highly complex
In basic terms, structured products are a geared gamble on the direction of the market and can be structured to pay off if the market gains, and still breakeven if it falls.

Although these products may appear very simple on the surface, underneath they are quite complex which means investors may buy in without fully understanding the risks. The returns of structured products are linked to an index or stock, but don't actually invest in them. They are created using derivatives, including options, forwards and swaps – investment tools that many investors would be scared off due to their risky and complex nature.

The investment method also means that you miss out on the dividends you would have received if you had invested in the stock directly – which are typically around 3% for the FTSE.

Despite the risks - there is a huge choice of structure products on the market to suit almost every investment profile and supporters claim they can be a valuable addition to a diversified portfolio. Yet with the structure and terms varying so widely across the board, the risk is heightened for private investors who dip their toe in without the expertise of an independent financial advisor.
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