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.
Structured products are generally made appealing to risk averse investors with cuddly round numbers offering ‘capital protection’. I’ll dissect one product for you.
The marketing title of the plan is: “FTSE100 Five Year Deposit Plan. Capital Protected.” Before reading one more line, what does that mean to you? The product brochure encourages “You understand how the Deposit Plan works”, or “You have read the brochure and understand how this investment works”.
No chance. Now, let me explain what it is. This scheme is marketed as 100 per cent capital protection at maturity and with an option for a potential 40 per cent (8 per cent a year) return after five years if the FTSE100 is greater than its opening level. 40 per cent return over five years is actually not eight per cent a year, AND it is not added per year.
This is misleading. You do not receive anything each year. Also, eight per cent per year would equate to a 46 per cent compound return. 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. 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. You should be frowning now. 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 counter parties were to become insolvent (unlikely), the customer would lose their entire investment and you are over to the FSCS to recoup losses. Your money actually buys an illiquid non-tradable, over the counter derivative. You will own a piece of unsecured paper that is simply a promise to pay.
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 what they want to for it. You also do not benefit from the dividends on the FTSE100 which have averaged around 3.74 per cent in recent years.
Average FTSE100 annual returns for five-year capital protected structured deposits maturing has been 3.75 per cent, 2.58 per cent, 1.82 per cent, 3.81 per cent and 4.57 per cent, over each of the last five years. Hardly exciting, and with no liquidity. In July, a five-year gilt offered 4.6 per cent with capital guarantee and total liquidity.
Also, when we look back at the 37 products that matured between 2018 and 2022, some 29 paid out and eight didn’t – a 22 per cent 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!
Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
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