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10 Reasons to buy a structured product - 18/02/2015

1. Defined returns- While a leap of faith is involved to an extent when buying funds in that the investor is trusting in the manager's ability to produce returns, the returns from structured products are defined at the outset. Understanding the terms of a product in its literature and considering the potential returns in various market scenarios is far from difficult and can make a massive difference when planning what returns you are hoping for from your overall investment portfolio.

2. Market protection barriers- Investing in a traditional passive investment, such as an index fund, equates to participation in the market rises, but also the market falls. Capital-at-risk structured products have 'barriers' which dictate that the market can fall by up to a defined amount, usually 40% or 50%, before the investment tracks the fall.

Structured deposits and capital 'protected' products offer capital protection regardless of market movements. Whilst the latter still carry the risk of loss if the bank behind the product becomes insolvent, structured deposits typically benefit from Financial Services Compensation Scheme protection, which covers depositors for up to £85,000 per institution.

The evolution of the structured product market has seen the release of defensive structured products, which offer returns even if the market falls up to a predefined amount, say 70% for example. These investments offer good diversification of risk in your portfolio and suit those investors feeling more cautious given current market levels.

3. Known maturity dates- As returns are pre-defined to be delivered on pre-defined dates, this can help with your financial planning. With a growth product this may be a set period over which returns are made, while auto-calls can mature early on pre-set anniversary dates if certain conditions are met, such as if the index is above its initial level.

If investing in an auto-call, the potential of an early maturity makes the prospect of reinvesting your investment proceeds more attractive. Whilst the maximum term of an auto-call is typically 6 years, the average term of an auto-call, when looking at 2014 maturities of the products distributed through Independent Financial Advisers, was 1.83 years, which indicates the reinvestment opportunity when buying auto-calls.

4. Market beating returns- Structured products are a type of passive investment. However, while traditional passives tend to follow the market, growth structured products often provide geared participation in the rise of the underlying index or even an attractive fixed return if the index rises by any amount.

Participation rates for products linked to the FTSE 100 have, for example, varied between 0.5 times any rise (more likely to be seen on structured deposits) up to over 8 times any rise. Participation is however typically capped at a maximum level and so the best case scenario is always known. Some structures historically have also offered a minimum return which would be payable if the market rises.

5. Bank based contracts- While banks have not always been given the best press, it cannot be ignored that they have been forced through regulatory action to shore up their balance sheets and are in better shape than before the financial crisis. So it is reassuring to some investors to have a major bank acting as the counterparty backing their investment.

A counterparty default can of course have a major impact upon investor returns. However, for those investors in the 1% of structured products backed by the collapsed bank Lehman Brothers, it hasn't been all bad news. Whilst some may have achieved recourse via the Financial Ombudsman Service or the Financial Services Compensation Scheme, others investors have been creditors of the bank and the liquidation process has seen many recover more than 37.5% of their investment to date, with more to follow.

6. Outcomes easy to understand- While the derivative options behind structured products may not be the easiest to comprehend, and we would argue it is unnecessary to know all the details, the potential outcomes are easy to understand.

Grasping the terms in the product literature, and using research tools such as, gives you the benefit of knowing the potential outcomes given all potential movements of the underlying asset. This is arguably more useful than other investments where an assessment of potential outcomes will be based on little more than past performance.

7. No ongoing charges- Most investments including funds have what is called an annual management charge, which is the fee paid to the manager for running the investments. This is an ongoing charge, which will be taken from your annual returns.

The benefit of investing in structured products is all the fees are upfront, which means that as you know the potential outcomes and when they can be delivered, you by default take into consideration the impact of all charges.

To put charges into context, providers rarely charge more than 2.5% for a six year product.

8. Past performance- Structured products have proven again and again that they do what they say on the tin and delivered consistent and enviable performance. Looking again at the 2014 maturity results, only 1% of products distributed through the IFA market produced a loss for investors. 94% made a gain for investors, while the remaining 5% returned capital only.

Looking at the whole gamut of products, the average annualised return was a healthy 7.35 per cent (6.72 per cent in 2013) achieved over an average term of 3.98 years (3.46 in 2013).

9. Diversifier to portfolios- While active funds, run by professional fund managers, take on risk to outperform the market, and other passive investments by their nature follow the market, structured products offer market and sometimes capital protection.

This means they are a good addition to investment portfolios to diversify the risk. Putting all your eggs in one basket may be a trite saying, but it applies as much to investments as to other aspects of life. By combining investments in a portfolio with different risk profiles and potential returns, you are more likely to get the results you want irrespective of the direction of the market to some extent.

10. Market growth not essential for returns- Getting a positive return from investing in equity markets usually depends upon growth in the equity underlying the investments.

A traditional structured product usually just needs the underlying asset on a predetermined anniversary to be above the initial level to mature with a gain. Therefore, structured products can make a gain in flat or only slightly rising markets. Also, with defensive structured products being launched, which offer the opportunity for a gain even if the underlying asset falls up to a pre-defined amount, this again shows their ability to make returns in what would be considered to be poor market conditions.

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