25 May 2009

Judith Evans

The adverts that triggered Credit Suisse and Yorkshire’s multi-million pound fines

Meera Patel, a senior analyst at Hargreaves Lansdown, is one sceptic. “Capital protection always comes at a price … if that’s lower returns, you have to question whether you might as well have your money in a bank account or gilts.”

One of the latest products, Skandia’s three-year Enhanced Dividend Seeker, offers income of 6% in its first year. But in its second and third years it uses a formula to calculate yield, based on dividends from FTSE 100 companies and the starting value of the FTSE 100 index.

In Skandia’s sample scenario based on the past five years, the formula would deliver a yield of 7.5%. A spokesman highlights that “obviously past performance of anything can’t be used to work out expected returns,” but also points out that the sample scenario would incorporate the past year as well as the preceding bull market.

However, Patel is sceptical, saying that many blue chip companies have cut dividends this year and she predicts more cuts. “Their example is probably optimistic, in my view,” she says, adding that the plan’s income might – depending on your economic view – sink just as interest rates on cash start to rise.

More broadly, she points out that many structured products are based on either dividends or growth in the stockmarket, not both. “If you want to make an investment into the equity market, then capital growth comes hand-in-hand with the income that’s delivered,” she says.

Investors in the Skandia product receive capital protection unless the index falls below 50% of its starting value, however. Structured product providers emphasise that not only such protection, but the promise of a more predictable level of growth or income than the equity market can generate, must come at a price – normally a limit on the upside.

Another new product promises what might seem like a magical offering – a way to recoup losses from long-only funds over the past year. Keydata’s Dynamic Growth Plan Issue 17 offers 10 times any growth in the FTSE 100 index, capped at a 90% return, over five years. Capital is protected unless the index dips below 50% of its original value.

Mark Owen, the sales and strategy director at Keydata, says the plan offers an advantage over equities if the index rises by any amount between 10% and 90%. Investors should consider, says Owen, whether they are prepared to have their returns capped at 90% and how much confidence they have in Citigroup, which backs the plan.

Investors will not know exactly where their money is, Owen says. “But when you go and pay money into your bank account, do you know exactly what’s happening to it?” In either case, up to £50,000 is covered by the Financial Services Compensation Scheme.

Still, for Patel, a formula-based return is “an instant turn-off … The more complicated the product, the more

it suggests to stay away from it.”

Chris Taylor, of Blue Sky Asset Management, is a vocal evangelist for structured products – but not all of them. He argues that a “halo effect” means star mutual fund managers lend sparkle to others who are less competent, while with structured products, the worst tar others with the same brush.

Rather than condemning products as sounding “too good to be true,” he argues, advisers should assess each one.

“Some providers look for cheap derivatives and headline rates,” he says. “Then they hope to find an investment story that they can wrap around cheap derivatives to raise some sales. But first and foremost you have to look for the investment driver.” He also cautions against low caps on returns, saying there are products capped as low as 33%.

James Davies, the head of research at Chartwell, says – like Patel – that his firm does not currently recommend structured products. “People need to remember that the ultimate risk you’re buying is a corporate bond,” he says; the experience of the Blue Sky Protected Income Plan (see news article) may also have contributed to his scepticism.

Like Taylor, he emphasises reading the small print – for instance, some plans offer a final return based on the closing value of the FTSE, but add that the “final value” is calculated by averaging the index’s performance over as much as 13 months. This reduces the impact of volatility but means investors may not see all the fruits of a bull market.

Taylor notes that his firm also offers products with 100% capital protection. His new FTSE 100 Protected and Guaranteed Growth Plan, he says, “does exactly what it says on the tin” – 100% protection, no downside risk, 150% of index growth, and FSCS coverage.

Meanwhile, Davies says he may recommend structured products to investors with a “specific requirement”. In fact, both Taylor and Patel use the word “sophisticated” to describe structured product clients.

Taylor says his fast-growing business is seeing the most interest “at the high end of the wealth management industry – with more sophisticated advisers, more demanding clients”. And Davies is prepared to concede that some products “are suitable for sophisticated investors” though he adds, “in the retail space, I’m less convinced of their suitability at all.”