Back

Beware of false knowledge; it is more dangerous than ignorance...

CompareStructuredProducts.com - 08/09/2021

Earlier this month we were disappointed to read misinformed opinions of two industry commentators broadcasted on a popular online financial publication.

In the article, an economist and a financial consultant are presented with a case study and asked to discuss the viability of commencing pension drawdown and withdrawing and reinvesting tax-free cash by reference to the client’s circumstances. As part of their annotation, the commentators discuss the client’s broad investment options, including structured products which had been suggested by the client’s appointed Independent Financial Advisor.

Firstly, the economist warns that he would “avoid structured products… as they are expensive and opaque”. He continues, “their main virtue is mitigating the effects of big falls in share prices” and then lists bonds, gold, cash and foreign currency as ‘better’ ways of mitigating said falls.

To describe structured products as ‘opaque’ is misleading and perhaps represents a level of ignorance; anything will seem opaque if you remain reluctant to look into it. Structured products, by nature, offer defined returns on defined dates – whilst there have of course been bad examples, labelling them opaque, with conations of uncertainty, is fundmantally incorrect.

For example, investors in a typical FTSE 100 linked capital-at-risk autocall plan will know that if the FTSE 100 Index is up by any amount on any anniversary, the plan will mature returning capital in full in addition to a gain of x% times the number of years in force. If the plan fails to mature early under adverse market conditions, investors can still expect to receive back their original capital at the end of the maximum term, unless the FTSE 100 is more than x% below the level recorded at commencement.

Contrary to the economist’s view, the main virtues of these investments, certainly in the UK market are not mitigating the effects of big falls in share prices but simply re-positioning stock market exposure to achieve defined, attractive returns in all but the direst of market conditions.

As for being ‘expensive’ structured products have an implicit fee, which is already reflected in the terms offered and clearly stated in the product literature. They do not involve ongoing charges or performance fees as with many alternative equity investments. The Deutscher Derivative Verband (German Derivate Association, 2015), summarised that “the costs associated with structured products are very transparent” and “when the costs are examined, it is clear that anyone under the impression that structured products are expensive is mistaken”.

Whilst the economist’s summation that the provision of downside protection through the incorporation of capital protection barriers is a virtue of structured products, his suggestions for ‘better’ alternatives seem somewhat questionable. Within two sentences the economist shuns structured products as opaque and suggests investing in foreign currency as a preferred method of mitigating equity losses, despite Forex markets being notoriously opaque themselves as currencies are traded in OTC markets where disclosures are not mandatory. The suggestion that cash is a better alternative that structured products fails to consider the erosive impacts of inflation, not least in such a low interest rate environment, which is surprising given his clearly stated concerns over property and it failing to protect against inflation.

Secondly, playing much the same tune, the financial consultant dismissed structured products, explaining that “you need to understand all of their risks and how they operate”, which of course begs the question – for which investments do you not need to understand the associated risks?

The FCA COBS 4.2 dictates that a firm must ensure any communication or financial promotion is fair, clear and not misleading. Resultantly, the literature for all products released by FCA regulated providers clearly and simply outline all associated risks with the relevant structured product, including the likes of counterparty risk, investment risk and event risk. Investors are required to read the product literature before investing, and if they do they so they should understand all of the risks, as with any other regulated investment.

With regards to structured products being “complex”, I refer back to by earlier point reinforcing the simple to understand defined outcomes offered by these investments. Despite what some commentators may suggest, the underlying makeup of a structured product is arguably no more or less complex than many other investments. Consequently, what we need to know and appreciate is what sits “on” the bonnet, and that, with structured products, can be very simple indeed.

Perhaps the most outlandish of all the comments made in the article was however the statement that “IFAs are of great value when it comes to navigating the forest of taxes and regulations. But they can be less helpful when it comes to deciding where to invest.” This statement, now removed from the online article, displays an even greater level of ignorance than that shown towards structured products. The IFA had clearly done his job properly and established that today’s UK structured product sector is indeed more than worthy of consideration. The empirical evidence is there for all to discover and those that dismiss the sector out of hand without doing the research, do their clients, readers and professions a gross mis-service.