Google my name and the word ‘structured products’ and you can fill your boots with 25 years of columns trying to steer you away from such ‘things’. This will be another.
I try to write like we are sat having a beer, wine or coffee together, but this ‘simple’ product is highly complicated. Please stay with me.
My biggest concern is that they are generally made appealing to risk averse investors with nice round numbers offering ‘capital protection’.
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Central to all of this is the line in the product brochure that states whether or not you should take out such a plan: “You understand how the Deposit Plan works”, or “You have read the brochure and understand how this investment works”.
There is virtually not a cat in hell’s chance of a normal independent financial adviser (IFA) being able to understand that line, let alone an investor. Strap yourself in.
I’ll take one product for you to consider as I dissect it. Firstly, here is the marketing title of the plan: “FTSE100 Five Year Deposit Plan. Capital Protected.”
Before reading one more line, what does that mean to you?
Now, let me explain what it is. Did I say, strap yourself in?
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This scheme is marketed as 100% capital protection at maturity (with a spiky asterix * next to that line) and with an option for a potential 40% (eight per cent p.a) return after five years if the FTSE100 is greater than the opening level of the FTSE100. Forty per cent return over five years is actually not eight per cent per year AND it is not added per year. This is very misleading. You do not receive anything each year. Also, eight per cent, per year, equates to a 46% compound return.
What’s not to love, of course? Well…the structure of the product involves three separate counterparty risks. Its marketing nudges customers to compare it to fixed rate deposits with exposure to equity returns, but it is neither a deposit nor equity. It is a bet, and if an investment banker offers you a bet, consider who knows the bet better.
If I marketed it as an opportunity to tie up money for half a decade with the possibility of no profit on your initial investment, it wouldn’t sound as sexy as the one above.
Now to its ‘simplicity’ as marketed above. Think of it this way. For every £100 you invest, around £85 is placed in a zero-coupon medium-term note designed to return that £100 at maturity. Around £5 (or five per cent) is used for the explicit fees, and the remaining £10 is used to buy a capped call option on the FTSE100. (See note above re understanding the product before investing). You should be frowning now. That’s ok.
Don’t think of it as a ‘joint package’ of a medium term note with a call option, its one instrument. Which means…if one of the counterparties eg: Royal Bank of Canada (RBoC) were to become insolvent (unlikely), the customer would lose their entire investment and you are over to the FSCS to recoup losses. While RBoC is listed as the deposit taker, your money actually buys an illiquid non-tradable, over the counter derivative. (It isn’t getting easier is it?) You will own a piece of unsecured paper that is simply a promise to pay.
Remember the capital upside is only paid at maturity. If you choose an early encashment, you are subject to the vagaries of stock market fluctuations, alongside trying to trade a completely illiquid note for which there is no secondary market, and they will just give you as little as they want to for it.
You also do not benefit from the dividends on the FTSE100 which have averaged around 3.74% in recent years.
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Looking back at average FTSE100 annual returns for five-year capital protected structured deposits maturing, it’s been 3.75%, 2.58%, 1.82%, 3.81% and 4.57%, over each of the last five years. Hardly exciting, and with no liquidity.
A five-year Gilt in July when this product was launched offered 4.6% with capital guarantee and total liquidity. Consider.
Also, when we look back at the 37 products like those above that matured between 2018 and 2022, 29 paid out, eight didn’t – a 22% failure rate.
So, if an investment banker asks you to take out a bet and ‘understand it’ how do you truly calculate the potential for loss. We can’t!
- If you have a financial query, please call 01872 222422 or email info@wwfp.net or visit us on www.wwfp.net
- Peter McGahan is the Chief Executive Officer of Independent Financial Adviser Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.