Clive Moore, Managing Director at IDAD Ltd - 15/10/2014
There’s a reason the World’s private banks sell a lot of structured products to their clients – they make more money selling structured products at a low margin than they do selling funds at a high margin. Obviously this is because the structured products are much more popular with wealthier investors than traditional funds. There are a number of reasons for the popularity of structured products amongst private bank clients; principal among them is the poor performance of the funds offered relative to the structured products. This isn’t solely due to the fact that the cleverer boys and girls work on structured products (although this helps), it’s principally due to the fact that the costs associated with structured products are a lot less than those associated with traditional solutions. Taking 2% a year from investments normally leaves them performing worse than investments that cost 0.5% per year – there is no particular alchemy, structured products are cheaper.
The traditionally negative press for structured products seems to have thinned out in the last year or so – the weight of evidence is finally tipping the balance. Many of the established fund groups now see structured products as an integral part of their wider portfolio offering, which means they are able to benefit from their outperformance, but still within a financial framework that suits their requirements.
Active fund managers may be drawn to the market-beating returns available with SPs, but for wealthier investors, it’s principally the delivery of an absolute floor for their investments that proves popular. Most of these investors have either generated their own wealth through hard work and smart thinking, or have inherited their wealth. For both types of investor, capital preservation is high on their list of priorities. Modest returns, delivering two to three times the return on a decent fixed rate deposit account (i.e. 5-9% p.a. at the moment) are more than adequate.
It is in this respect (delivering clearly defined returns) that structured products really shine. Investors and their advisers can determine their target return and then review the level of risk to capital and uncertainty in delivery of return that is associated. For example, a FTSE 100 linked auto-call can deliver annual returns of around 9% p.a. if the index manages to hit the current level on one of the anniversaries from the second year onwards. This is a simple performance target for investors to understand, and the capital risk that comes with the investment (full capital return if the index is above 50% of its value at maturity and hasn’t called beforehand) is also easy to understand. Contrary to popular belief, this clarity of outcome or simplicity in the product is another reason they’re popular.
Clients who have generated wealth by building up their own businesses have demonstrated an ability to make money. If they want to grow their wealth substantially, they are more than capable of doing it themselves and are unlikely to be looking for stellar returns on their investments. The simplicity of structured products can be appealing to these people, but very often they appreciate the ability to have a clear understanding of what returns will be delivered by their investments in different market conditions. Some may even enjoy having a high level of input into the investment parameters, and this is quite easy in the structured product market. For relatively modest sums, clients can have an investment tailored specifically to meet their objectives, either by way of a link to a particular portfolio of underlying markets, or through the shape of the payoff. Most structured product providers can deliver bespoke products, and there are a number of dedicated firms also doing this.
Concerns over counterparty risk have mostly dissolved in recent years, but it’s always easy to deliver “sexier” returns by tweaking the credit shape of a structured product. Thankfully, participants in the UK market seem largely to be resisting this temptation, and they deserve considerable credit for doing so – it isn’t always easy to choose ethics over profits (as we’re reminded by the activities of many parts of the banking industry on an almost daily basis). Investors have a choice of counterparties and can even look at collateralised solutions to reduce the risk further. Great progress has been made in explaining the credit risk to investors, including some excellent comparative tools that allow them to contextualize the risks.
The “risk” information provided by structured product providers is generally far more helpful than the SRRI (Synthetic Risk Reward Indicator) agreed upon by the CESR (Committee of European Securities Regulators) which the fund world seems stuck with. The SRRI is based on fund volatility, but is widely promoted, as intended, as a measure of risk. So when regulators complain that “low risk” investors have lost a fortune through investment in sub-investment grade emerging market junk-bond funds, they only really have themselves to blame (volatility is still low on these funds).
Ultimately investing can be compared to racing driving – it’s not always the car that’s fastest on the straights that wins, often it’s more important to be less slow on the corners than your competitors. Structured products can deliver accelerated returns in rising market and preserve capital when markets deviate from an upward only trajectory. It’s these attributes that attract wealthier investors and allow them to achieve the one goal they pretty much all have in common – to stay wealthy.
The views expressed in this article are those of the author and do not necessarily represent those of CompareStructuredProducts.com.
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