Disadvantages of Structured Products

As with any investment it is important that you fully understand, and are entirely comfortable with, the risks associated with structured products and that you take advice where you are in any doubt.

Hereunder are some of the things that those unfamiliar with structured products should be mindful of when considering investing; with such a wide range of different products available it is imperative that you fully understand the rules associated with a particular product before making an investment.

• Lack of Liquidity

Structured products are generally issued for a fixed term and whilst there is a secondary market for some, even among those which can be traded, investors may not get all of their original investment back.

Before signing up to what may be a six year commitment, it would be wise to consider circumstances in which you may need access to the capital you may tie up and the potential impact of an early exit.

• Costs

The costs of structured products may not always be clear and may be presented as ‘all inclusive’, however, they can be expensive with charges of 7% not uncommon.

• Risks

         

Markets have been volatile of late and even the most ‘vanilla’ structured product may deliver returns that are subject to the vagaries of the FTSE 100.

This is where it is imperative that the investor understands the precise rules of the product they are buying – predicting that the FTSE 100 will rise by a set percentage each year may not be too gamey, but the product may specify that the target figure has to be reached on a particular day, which makes them vulnerable to unexpected, short-term, events.

The greater the returns a product seeks the more complicated it can become and the higher the risk is likely to be; a product linked to several exchanges, will carry more risk than one that is based upon a single index and a product linked to individual shares will be riskier still.

• Lack of Flexibility

Once you commit to a product, that is pretty much it for its duration; if your circumstances were to change when you were invested in shares or bonds to change tack is relatively simple, but that is not the case with structured investments and the terms of the product are non-negotiable.

• Limited upside

The return on structured products is usually capped so that investors will not generally reap the full benefit if an index sky-rockets; however, that is generally seen as a trade off against the capital protection that is offered and at the cap returns should be generous.

What to consider

• Counterparty Risk                      

How stable is the bank behind that is underwriting the product – what is its credit rating?

• Product Risk        

What is the return of the product linked to – the more indices or the fewer individual shares, the higher risk it will be.

• Product Targets              

Are the targets the product sets realistic – the more the index has to gain in order to reach its threshold, the less likely it is it will be achieved?

• Capital Risk         

How much of your capital will you lose if the index does not perform as targeted?

• Charges                

What are the costs associated with the product?

• Penalties for Redemption

If you are able to foreclose on the deal early, how much will it cost you?