The Financial Group
We simplify all those essential financial decisions
THE EDUCATION SECTION   November 2011 Every month we look at a particular financial topic in a little more detail. This month it is Structured Products ____________________________ What is a Structured Product? Structured Products can be any one of a wide range of investments and can offer - income, capital growth, or a combination of both. Most   structured   products   tend   to   be   open   to   new   investment   for   a   short   period   of   time.   Funds   will   then   usually need   to   be   tied   up   for   between   one   and   ten   years.   Some   structured   products   offer   full   capital   protection,   but others offer partial or no capital protection. What are the benefits of Structured Products? They combine the benefits of stock-market returns, with limited downside risk. How do they work? Structured   products   offer   returns   based   on   the   performance   of   underlying   investments.   Many   products are   linked   to   a   stock   market   index   such   as   the   FTSE   100.   The   underlying   investments   may   involve different firms based in various countries. A   typical   structured   product   will   have   2   underlying   investment   components:   a   note .    This   component   is used   to   provide   capital   protection.   It   may   pay   interest   at   a   specified   rate   and   interval,   and   may   repay some   or   all   of   your   original   money   at   maturity;   and   a   derivative .   This   component   is   used   to   provide   the potential growth element that you could get at maturity. Investors   are   usually   offered   only   a   share   of   any   increase   in   the   level   of   the   index   or   asset   price   which occurs during the term of the investment. How is your capital protected? Even   if   a   product   offers   ‘capital   protection’   it   can   sometimes   fail,   causing   you   to   lose   some   or   all   of   your original   money.   For   this   reason,   if   you   decide   to   invest   in   structured   products   then   it   is   wise   that   they form   only   a   small   part   of   a   balanced   investment   portfolio.   You   should   also   consider   spreading   your investment   between   several   products   which   rely   on   different   financial   institutions   to   protect   your   money. It   is   important   to   be   aware   which   financial   institution   is   ultimately   responsible   for   offering   any   ‘capital protection’. Structured products offer two broad types of capital protection. o Full   -   described   as   ‘100%   capital   protection’,   ‘capital   security’   or   a   ‘capital   guarantee’.   This   aims   to return   all   the   original   money   invested   at   the   end   of   its   term,   regardless   of   any   fall   in   index   level   or asset   price.   Remember,   though,   that   the   cost   of   offering   this   protection   will   affect   the   returns   you get, and there is still a chance you could lose some or all of your original money. o Partial   -   often   offered   by   ‘structured   capital-at-risk   products’   (known   as   ‘SCARPs’).   This   aims   to return   the   original   money   invested   at   the   end   of   the   term   unless   the   index   or   asset   price   to   which the product is linked has fallen below a predetermined threshold. What about structured deposits? Some   structured   products   are   deposits   rather   than   investments.   Structured   deposits   (often   marketed   as ‘guaranteed   equity   bonds’)   can   only   be   offered   by   firms   such   as   high-street   banks   which   are   able   to accept deposits. Your   money   is   treated   as   if   it   is   in   a   restricted-access   bank   account   but,   unlike   a   traditional   savings account   which   pays   a   fixed   rate   of   interest,   the   interest   you   receive   will   depend   on   the   performance   of   a stock market index or asset. It   is   important   to   note   that   you   may   not   be   covered   by   the   Financial   Services   Compensation   Scheme (FSCS) if the firm holding your deposit goes bankrupt. Key risks and product features. The following list is not exhaustive and not all risks or features are applicable to each type of product. Credit   risk    –   a   product   may   be   designed   and   marketed   by   a   ‘plan   manager’,   but   the   returns   and guarantees   are   generally   provided   by   a   third   party.   If   that   third   party   goes   bankrupt,   you   could   lose   some or   all   of   your   money,   even   if   a   product   is   called   ‘protected’   or   ‘guaranteed’.   You   may   not   be   covered   by the   FSCS   if   this   happens.   When   selecting   a   suitable   Structured   Product   it   is   important   to   assess   the   credit worthiness of the relevant counterparty by reviewing their CDS rating . Market   or   investment   risk    –   if   the   return   of   your   original   money   depends   on   the   performance   of   a   stock market   index   or   asset,   then   if   the   level   of   that   index   or   asset   falls   during   the   term   of   the   investment   you may   lose   some   or   all   of   your   original   money.   If   this   happens,   you   could   lose   your   original   money   very quickly. Liquidity   risk    –   the   benefits   offered   (such   as   capital   protection)   are   usually   only   available   if   the   product   is held   for   the   full   term.   It   may   be   difficult   or   expensive   to   access   your   money   before   the   end   of   the investment term. No   dividend   income    –   even   if   a   product   is   linked   to   the   performance   of   a   stock   market   index,   you   will   not receive any dividend income from the companies which make up that index. Capped   returns    –   many   products   restrict   or   cap   the   level   of   the   return   you   can   receive,   so   if   an   index   or asset price rises above the level of that cap, you do not receive additional returns. Averaging    –   the   return   offered   by   some   products   can   depend   on   several   measurements   of   index   levels   or asset   prices   during   the   life   of   the   investment.   While   this   can   protect   you   from   short-term   falls   in   an   index level or asset value, it may also prevent full exposure to any gains. Limited   participation    –   many   products   only   offer   a   proportion   (for   example   50%)   of   any   gains   made   by the index or asset to which they are linked. Inflation   –   even   where   a   product   is   marketed   as   ‘100%   capital   protected’,   the   real   value   of   the   capital   can suffer significant erosion by inflation over the term of the investment. Tax   –   the   tax   treatment   of   structured   products   depends   on   their   legal   structure   and   on   any   tax   wrapper   in which the product is held. Structured products are often complicated. You should seek professional advice if you are in any doubt about the potential risks and returns involved. You could lose some or all of the money you put in to these products, so make sure you understand the risks before investing.