A guide to Structured products

Structured products sometimes known as Future Value Products are investment vehicles designed for investors who wish to combine the potential upside of stock market growth with a guarantee that they will get their original investment back. There are also products, which will provide a higher potential return with an element of risk to capital, which are known as Structured Capital At Risk Products (SCARPS).

Structured retail products (SRPs) first appeared around 20 years ago in the UK. When they were launched in general the retail products were investment bond-based, promising a simple percentage return of the FTSE index or your money back over typically a five year term. Life companies were the natural starting point for such offerings because they could provide a guarantee (not 'protection'), but for a variety of mostly tax reasons other wrappers later emerged.

In today's more sophisticated and demanding investment marketplace there is a vast offering of different SRPs available with new offerings being promoted on a regular basis.

Among the main features of products are:

* Fixed terms - Most plans have a fixed term, more often than not between five and six years, to meet the eligibility rules for the stocks and shares component of an ISA. There are also a number of variants known as kick out plans where if the market performs in a particular way the plan will mature yearly with a specified return.
* Capital protection- Many products will offer less than 100% protection although the 100% floor remains quite common and popular.
* Formula-based returns Structured products generally have formula-based returns. It is important to understand the formula because with an SRP what you see is what you get.
* Complex structures - Probably the most common index utilised in these plans in the UK is the FTSE 100, but there are many more complex structures available now, with kick outs, accelerated growth, capping and even positive returns for negative market movements

What factors should be considered when considering a structured product?

Asset class - as mentioned the majority of plans are linked to the performance of the FTSE 100, although it is possible to find a few other asset links, e.g. a house price index, individual funds or non-UK indices. Performance is generally based on pure capital index performance, i.e. no account is taken of income. That can make a considerable difference for FTSE 100 plans: the approximate current net dividend yield on the FTSE is 5.75%, which would accumulate to 32% of the original investment over five years.

Hard protection - Hard protection means a fixed level of protection, regardless of asset class performance.

Soft Protection - with soft protection, the protection falls away if the asset value breaks a given barrier, typically 50% of the initial level.

Counterparty risk - Products will often involve three parties: a product provider, an out-sourced administrator and a supplier of the underlying derivative-based investment (the counterparty). The counterparty is usually a bank and, if it fails, the SRP could become worthless: SRPs (other than deposits) are protected, not guaranteed.

Averaging - The formula-based returns of plans often use more than just an index reading at the start and end of the product term. For example, in growth plans the final reading may be averaged over six or twelve months. This means last minute crashes (and spikes) are dampened. However, in theory it will also mean more often than not a lower final reading than if there had been no averaging and only an end point value had been taken.

Gearing- Some plans offer considerable gearing. For instance, it is possible to find plans that offer 4 times the growth in the FTSE 100, albeit with a cap. High gearing normally comes at the cost of soft rather than hard protection, but can be very attractive if market performance is only modestly upwards.

Tax - The product format of products is often driven by tax considerations. Most growth products are subject to capital gains tax, although matters get more complicated when there is a 100%+ minimum return. For many investors, wrapping growth products in an ISA is a waste: the capital gains tax annual exemption will suffice

With the current investment climate and high levels of volatility still being experienced this could point to continued growth in the Structured Product market over the remainder of 2009. These plans have the potential to give investors higher returns than current deposit accounts with downside protection. However if there is a significant change in interest rates due to high inflation for example then most plans will penalise the investor if they want to withdraw prior to the maturity date to invest elsewhere.

Structured Retail Products and the risk involved particularly in relation to counterparty risks need to be understood at outset by the investor. In practice that means the role of a good Independent Financial Adviser (IFA) is vital

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