It’s hard to know where to invest your money at the best of times. Compounded by deposit returns from cash, although rising, not keeping up with inflation. Could Structured Investments be worth considering as an opportunity, offering potential returns in a flat or even falling market? If that sounds of interest read on…
What are Structured Investments?
Structured Investments are fixed-term investments where a reading of a market index such as the FTSE100 is taken at the beginning of the plan. The plan then offers specified returns if the pre-decided conditions are met. The plan is only open for a given period, after which it closes and normally a new one opens.
There are two types of plans, and it is important to understand the difference between the two:
These plans offer the potential for an enhanced return on your investment compared to a traditional cash deposit. Although neither the plan nor the deposit tracks the index directly, their performance will affect any interest payment. You need to understand that this will be impacted by a number of factors.
Unlike Structured Investments (see below), the capital you first invest normally benefits from financial services compensation scheme protection of up to £85,000.
Structured Investments are commonly offered by banks. Typically, your money buys two underlying investments; one to protect your capital and another to provide the return. However, your capital is at risk, and the return you get depends on how the stock market index or other measures perform.
A popular Structured Investment is the ‘Kick Out’ plan. There’s even one called a Step-Down Kick Out plan, which sounds more like a line dancing move than an investment! The terms and rates will differ from provider to provider and between specific tranches.
How does a Structured Investment Kick Out plan work?
A typical Structured Investment Kick Out offering might look something like this…Let’s say you invest your £20,000 ISA allowance and at the beginning of the investment term, the FTSE100 stands at 6800. Typically, if on the predestined 2nd anniversary year of your plan, the FTSE100 is at 6800 or above, the Kick Out plan will mature and return your capital with a fixed rate of return of say, 7% per annum. The rates differ between offerings and are fixed from the outset.
What if the markets have fallen?
If the markets have fallen below 6800 then the plan doesn’t mature at that point but rolls on to the following year when the same test is done. The plan then either matures and pays 7% x 3 years, or rolls on to the next anniversary (because the FTSE100 is still below its start price) and so on.
Either the FTSE100 will move above its start price on one of the anniversaries during the plan’s term (this is typically 6 to 8 years), in which case your money is returned with a 7% return for every year it’s been in force. Or, the FTSE100 could still be lower than its start value at the end of the term.
The FTSE100 is still lower than its start value, what happens now?
If the FTSE100 is still lower than its start value, one of two things could happen:
1. The index is above a specified threshold
If the index is above typically 60% of its initial value (so in this example, this would be 4080), then your full investment is returned with NO growth.
2. The index is below the specified threshold
If the FTSE100 is actually below 4080 on the maturity date (European Barrier*) then you’ll take a loss. However, this is also true if you had invested in an index tracking fund, just in a slightly different way. Although unlikely, it is possible that the index could fall below the start point even after 6-8 years.
*A European Barrier is where the index is tested just once at the end of the period. Less common are plans that use an American Barrier and aim to return the original capital at maturity unless the underlying asset falls below the initial level by more than a specified percentage at any point during the investment term.
Structured Investments summarised
With Structured Investments, you have the potential of a really good fixed rate of return and are not necessarily reliant on the market having to rise. If it doesn’t have any special tax wrapper (see below) then the proceeds would be liable to capital gains tax, for which you have a personal allowance (currently £12,300 2022/23 tax year) to use before you have to pay any tax.
It could get even more tax-efficient…
If your Structured Investment is held within an ISA or a SIPP, it leaves your capital gains tax allowance for other investments – so even better.
The risks with Structured Investments explained
The main risk is that the markets could fall substantially and remain below the level where your capital is returned. If this happened, you’d take a corresponding hit on your investment and wouldn’t receive any return.
Structured products are generally quite complex. They contain various features that can make it difficult to compare them with other alternatives. As a result, many product providers will not allow investors to buy direct without seeking financial advice. You need to have a confident understanding of the various terms, know who is providing the return, and fully understand that your capital is at risk.
There is also something called ‘Counter-party Risk’ to consider. When you take out a Structured Investment with a bank or insurance company, it’s not actually them promising to return your original investment or to pay a given return on your money. Your money typically buys two underlying investments from the plan’s counter-parties; one to protect your capital and another to provide the return. The return you get depends on how the stock market index or other measures perform.
How does counter-party risk work?
Because you don’t have an agreement yourself with the counter-parties, if your Structured Investment fails to give you your money back or provide the promised return, you don’t have a direct claim on them, and no compensation scheme applies. Some plans use a spread of counter-parties as this helps mitigate single issuer risk, and also reduces the impact felt should a single counter-party fail.
It’s all about understanding risks and finding the right structured product backed by a financially strong secure counter-party. The skill is in establishing whether structured products are right for you and choosing between the different types of products available. That’s where your financial adviser’s expertise comes in!
The choices are endless! Ensure you understand the mechanics of the plan you are taking out, and that you have the appetite and capacity to withstand a potential loss of capital.
It is worth noting you may not get back your original investment if you encash early.
The figures and product features in this article are used for illustrative purposes only. The example shows a Kick Out Structured Investment with a European Barrier. It is important that your financial adviser fully explains the features and terms of any plan before you proceed.
The rates and examples that have been used are also very generic – terms change from product to product and even tranche to tranche with the same provider.
Remember, the “safer” the plan, the lower the potential rewards and vice versa. You may get more by investing directly in the stock market if it is a rising market. You wouldn’t get any protection from any falls.
Try not to let the risk factors automatically put you off. These plans have been around for a long time and have proved very successful investments for many doctors and dentists with ‘an appropriate’ risk appetite. They are only ever used as part of a balanced investment portfolio.
Without a doubt, we are facing uncertain times which are affecting the markets and rising inflation, but you still need to take steps to make your money work for you – perhaps now more so than ever.
Get in touch if you would like to discuss Structured Investments further.
Are structured investments a potential investment opportunity for you? Let us know by adding a comment below.