In volatile times there are still investments that offer a safe haven
There are ways to guarantee returns, but always read the small print, warns Esther Shaw
In today’s volatile stock market, some anxious investors are cashing in their equity investments and rushing to reduce their exposure to risk by taking shelter in lower-risk asset classes. Finding a safe haven is no mean feat right now and following the years of plenty, people are starting to look for innovative products that will see them through the rough times.
Among the investments that are increasingly attracting attention are structured products. The principle behind structured products is that investors can have some upside exposure to an asset or index, while being protected from the downside of the markets.
Structured products were once the preserve of the institutional or ultra high-net worth investor, but that is no longer the case. New figures from Blue Sky Asset Management (BSAM), show that sales of structured retail investments reached almost £3.7bn in the six months to the end of June – a 15 per cent increase over the comparable period of 2007. Sales of structured retail investments hit £3.688bn in the six months to June 30th – a 15 per cent increase over the comparable period of 2007.
Growth Area
Figures from the Investment Management Association (IMA) show that UK-domiciled funds under management saw £27.5bn in redemptions to the end of May 2008, while in the US, 24 out of 25 mutual funds saw assets decline.
That said, the UK currently lags behind other markets in the popularity of structured investments. The BSAM figures show that total sales in the first six months of 2008 in Europe were €127bn, US sales were $27.9bn, and in Asia, excluding Japan, they were $84.2bn.
So what exactly are these investments? A structured product is typically a fixed term investment that offer investors a predefined return based on an index, such as the FTSE – or a basket of indices – over three or five years. There is often the guarantee that the original capital will be returned at maturity – and sometimes even a minimum return too.
This means that if, at the end of the period, the index has risen, your investment will mirror a proportion of the rise in that index. But by the same token, even if the underlying investments fall, you will still usually get most or all of your money back at the end of the term.
Capital Protection
Elliot Farley, senior analyst at fund of fund specialist T Bailey, is a keen supporter of structured products, but warns investors that they need to be handled with care: “Investors are interested because they can provide access to markets with an element of capital protection in case they go down, and secondly, that they can provide upside gearing – or extra growth – for investors taking a view that the market is heading upwards.”
While these investments may sound rather appealing, you have to remember that if you’re buying a product that offers capital protection, you’re not going to get this for free.
Hugo Shaw from investment broker Bestinvest says: “Structured products may sound like a no-brainer, but investors must not be swayed by the headline figures. Crucially, you will not receive dividends from structured investments linked to equities, and for high-yielding markets, such as the UK, this can form a considerable portion of the total equity return.”
While investment terms are usually three to five years, very few structured products have any sort of secondary market, which means that investors are committed for the duration.
If the equity markets are doing well there’s no way to pull out your cash and reinvest it. You could be missing out on a bonanza, and paying a high price for the guarantees that structured investment give.
Further, as an investor it is crucial that you understand what is meant by “guarantee.” When it comes to structured products, this is not an absolute term, it seems. Many in the industry remember the “precipice bond” scandal a few years ago, when investors were offered a high level of income at 10 per cent per annum over five years with a “guaranteed” return of capital.
But what was not well explained was that the 10 per cent was deemed a return of capital. At the end of their five years, the market had fallen and many investors only received half of their original capital back.
Horse Sense
Investors should also be aware of what is known as “counterparty risk”. Bestinvest’s Hugo Shaw says: “Where offered, the guarantee to pay capital is only as good as the financial strength of the company providing it. Sometimes this is spread across several institutions and sometimes it’s with just one. It’s worth asking who is lurking in the shadows.”
Farley adds that structured products are “a bit like insurance. The cost of that protection is often sacrificing dividend income, and maybe even some of the potential upside. Some would argue that with the markets having dropped so much, now is not the time to be doing that. It’s a bit like insuring your horses after they have bolted.”
Others are more bullish, though. The FSA has ensured that structured products have improved over recent years, and many now come with safety features. Despite all the caveats, wily investors should not be frightened away from structured products.
Investors who want to develop their portfolios beyond mutual funds and trackers might be tempted by them, but financial advisors say that they ought to be used to complement a portfolio – and not to replace it.
They can be particularly useful for sophisticated investors, and can be a good way to give yourself exposure to unusual areas that are not easily accessed in other ways, such as emerging regions and commodities.
They don’t come risk-free, though. As with all products, you should make sure you read the small print, and if you don’t understand what you’re being sold – don’t buy it.
