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Understanding different structured product types

CompareStructuredProducts.com - 04/03/2015

There are a range of different structured product types available to the retail market. In this article we go through the most common types and consider their appropriateness for different investors and different market scenarios.

Auto-calls (or kick-out products)

An auto-call may have a maximum term of, say, 6 years but can mature early on specific anniversary dates, if pre-set conditions defined in the product terms are met. The most simple example of this would be if the underlying asset (for example the FTSE 100) is at or above its initial level a year after the start date, the plan would mature / kick-out, returning investors’ original capital in full together with a fixed coupon.

If the FTSE 100 is below the initial level the plan continues until the next anniversary date when, if the FTSE is higher the plan will mature returning original investment plus two times the fixed coupon. This continues each year, adding another fixed coupon each year until either the plan ‘kicks-out’ or it reaches the end of the investment term which is typically six years. If the FTSE is higher the plan matures returning original capital plus six times the fixed coupon, if the FTSE is lower the plan returns original capital only, unless the FTSE has fallen below the barrier (typically 50% of the initial level) in which case the original capital will be reduced in line with the fall in the index over the investment term.

If investors have a moderate or positive market outlook to the extent that they believe the markets will rise in the short-term, an auto-call is an option worth exploring, as they can mature on defined dates with defined gains in the event of very moderate market rises or, in certain cases, moderate falls. For those investors keen to reinvest their proceeds, they can put this money in rollover substitutes from the same provider, another offer or opt back into the markets via their mutual funds.

Looking at the structured products that matured last year distributed through the IFA space, auto-calls made up 31.91% of the total number of products maturing. With an average term of 1.83 years and an average annualised return of 9.14%, they were comfortably the best performing of all of the structured investment types.

The results achieved by the FTSE 100 only linked auto-call products were slightly lower than those achieved by non-FTSE 100 linked products when looked at on an annualised basis (8.26% over 1.65 years for FTSE linked and 10.33% over 2.13 years for non-FTSE auto-calls). This reflects the higher risk/reward trade-off with non-FTSE products.

Currently there are 20 auto-calls on CompareStructuredProducts.com. Here is one of our preferred plans (please note that this may not be suitable for you and this should not be construed as a recommendation to invest)-

Walker Crips Annual Growth Plan Issue 32 (Kick-out)

This maximum six-year plan features the potential to mature on any of the plan's anniversaries from year two onwards, provided that the FTSE 100 Index closes at a level equal to, or higher than the initial index level, returning the capital investment in full, plus an 8.25% gain on the invested capital for each year the plan has been in force.

If the plan fails to mature early and the final index level is below the initial index level, no gain will be made. However, capital should be returned in full unless the final index level is more than 50% below the initial index level. If such a fall does occur, the invested capital will be reduced by 1% for every 1% the final index level is below the initial index level.

The counterparty to the investment is Santander UK, which has a S&P and Fitch rating of A and a Moody’s rating of A2.

Growth

This product type is designed to provide growth, which can be a fixed return dependent on underlying asset performance over the investment term, or geared participation, a multiple of the rise, in the same performance. Participation in the underlying asset is often capped at a maximum return of the invested capital and some deposit based plans also offer a minimum return.

If an investor feels even slightly positive about the market direction and is willing to lock their money away for a certain period, usually 5 to 6 years, a growth structured product could be appropriate for their portfolio. The geared participation element of some growth products means they can seriously outperform traditional passive investments such as index funds. Some growth plans can also make good returns even if the markets go sideways, an attractive potential outcome for more cautious investors.

Looking at the structured products that matured last year distributed through the IFA space, growth products made up 47.23% of the total number of products maturing, with an average term of 5.09 years and an average annualised return of 4.26%. This performance was inhibited by some of the non-FTSE 100 linked growth products. Those growth products linked only to the FTSE 100 produced more attractive returns with an average annualised return of 7.52% over an average terms of 4.95 years..

Currently there are 6 growth products on CompareStructuredProducts.com. Here is one of our preferred plans-

Societe Generale UK Defensive Growth Plan (UK Four) Issue 1 (Collateralised)

This six-year product offers investors the potential for growth at maturity equivalent to five times any rise in the FTSE 100 Index above 90% of its initial index level, subject to a maximum gain of 60% which would be achieved if the index rises by 10% or more.

If the final index level is equal to or below 90% of the initial index level, no gain will be made. However, investors' capital should still be returned in full, unless the final index level is more than 40% below the initial index level. If such a fall does occur, the invested capital will be reduced by 1% for every 1% the final index level is below the initial index level.

The credit risk is exposed to four UK financial institutions. The Standard & Poor's ratings for the four institutions are; Aviva plc (A-), Barclays Bank plc (A) Lloyds Bank plc (A), and The Royal Bank of Scotland plc (A-).

Income products

A structured investment typically designed to provide income, payable monthly, quarterly or annually. The design of the product, in terms of the potential returns and the frequency of payment, will define which investors it is suitable for depending on their individual income requirements.

Income products are not suited to a specific market scenario, but are bought to suit particular investors’ needs. The search for income, especially given low interest rates, is always high on the agenda for most investors, particularly those in later life with income requirements throughout retirement.

Looking at the structured products that matured last year distributed through the IFA space, income products accounted for 17.45% of all products, with an average term of 5.18 years and an annualised return including gross income of 5.96%. This figure was again pushed down by the performance of non-FTSE 100 only linked plans, including two linked to banking shares that produced negative returns. The average annualised return achieved by the top 25% of income products was 7.13%, while for the bottom 25% it was 3.88%.

Investors have historically relied upon traditional asset classes to provide income for their clients, but the defined nature of income returns with a high level of capital protection offered by income structured products should challenge relying completely on these.

The majority of the income structured product market are what are called conditional income plans. This means that the payment of any income is dependent on the performance the underlying asset(s). Some conditional income products have a memory feature that will, subject to circumstances, pay any coupons that went unpaid due to the prior performance of the referenced asset(s). However, investing in a conditional income product will mean investors need to accept the risk that if the pre-set conditions on the product are not met then the level of income hoped for will not be achieved. There are two income products currently listed on CompareStructuredProducts.com.

Hybrid products, such as income with auto-call and growth with auto-call, show the flexibility of structured products in terms of their design. Also, holding a combination of different product types can also work to investors’ advantage. For example, growth products that will reach their full maturity are often held in the same portfolios as auto-calls, which have the opportunity to mature early. In that way, investors can expect staggered capital gains, allowing them to plan their usage of the CGT tax allowances.

Whatever the product type, each product needs to be assessed on its own individual merits. The defined returns of structured products means that you do know exactly how a product will perform in different market scenarios. This is a benefit to investing that should not be overlooked and show structured products as a valuable addition to a diversified investment portfolio.

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