A structured product is a pre-packaged investment strategy based on an underlying index and a derivative. There are many types and no standardisation, which means they are complex. To help you decide if structured products belong in your portfolio, here is an overview.
If you are thinking about investing in a structured product offering your first questions should be:
- How does it work?
- What are the risks?
- Am I protected by a financial compensation scheme if things go wrong?
You need comprehensive answers to these questions – and should be able to find them in product literature. It’s best to ask more questions if something isn’t clear.
Structured products have grown in popularity in the UK but have been a regular for investors on the continent for years.
They are used as a complement to other investments in a portfolio and/or as a defensive investment strategy, as they have the potential to pick up gains in either bear (when the stock market is down) or bull (when the stock market is up) market conditions.
What’s inside a structured product?
They are an investment of a fixed term backed by counterparty (or counterparties) with a payout that is defined based on an underlying measurement (of an asset such as shares or a stock market index – often the FTSE 100 or a foreign index).
No matter how you cut it, structured products are riskier investments but the risk to your capital is compensated for by a potential for a much higher rate of return.
How much gain will be defined, but whether or not you receive that gain is tied to how well the underlying asset (usually a stock market index) performs.
These plans are structured like loans to a bank or other financial institution using zero-coupon bond and derivative package, often an option.
Zero-coupon bonds pay no interest during the term of the bond but return the original capital at maturity. An option is the right to buy ‘call’ or sell ‘put’ a set quantity of an asset at a given price on a specified date in the future.
Getting your money back plus the promised return depends on the issuing institution remaining financially solvent.
Counterparty risk needs to be considered for structured investment type products because, unlike structured deposit plans, there is no compensatory scheme if the institution is unable to meet its obligations. You can lose your investment.
Products are meant for holding until maturity. However, it is possible to sell your structured product during the term but with the caveat that you may not recoup your initial investment.
The risks to capital
Structured deposits benefit from protection from the Financial Services Compensation Scheme (FSCS) up to a maximum amount.