Structured Products in a Balanced Portfolio
It is important that the DIY investor ensures their portfolio is diversified across industry sectors, individual investments and asset classes to ensure that any loss associated with a dramatic change in fortune for one does not do catastrophic damage to their overall wealth. By Jemima Reeves
As interest on cash deposits remains stubbornly low and bonds markets are lacklustre, the unusual risk/return profile of structured products may appeal to investors looking for improved returns but with some protection for their capital in all but the direst circumstances; structured products can be considered to offer more risk than cash and less than shares.
Structured products could be used to diversify a portfolio where the investor is looking at a time horizon of more than five years, and those less inclined to actively manage their portfolio may take comfort in the fact that a criticism sometimes levelled at structured products is that their fixed terms and fixed term mean that they may lack ‘excitement’.
When equity markets show little growth any investment in a traditional equity fund would be eroded by its charges; in the same market conditions, a structured product may offer you a return with a kick out clause based upon the FTSE 100 remaining at the same level at a point in the future.
‘structured products can be considered to offer more risk than cash and less than shares’
As an alternative to low yielding bonds, or a cash deposit account, it is possible to buy a structured product that returns 5% a year if the FTSE 100 hasn’t fallen more than 10 per cent on the fourth, fifth or sixth anniversary.
Defined returns can remove the uncertainty and additional cost of active management, as the investor knows what the return will be under certain circumstances, and when it will be.
Structured products may save the DIY investor from the classic buy high, sell low mistakes that can come from trying to chase, or time, markets as once an investment is made the date for crystallising any return is fixed.
The fixed term of a structured product need not mean that the investor relinquishes control of his capital for the duration of the product; it merely means that any control is exercised when choosing the product in the first place.
It also makes sense to diversify within a particular asset class and structured products allow the investor to select products with different risk/reward characteristics – e.g. by putting half of an investment in a product that pays 6% as long as the FTSE 100 stays above 80% of its initial level, and the other half in a product that pays 8% if the index stays above 90%, the aggregate return on the entire investment is 7% as long as the FTSE 100 stays above 90%.
Structured products display the same risk/reward characteristics as any other investment, the difference being that the precise levels of risk and return are clearly established in advance and built into each product.
There is no right or wrong when it comes down to the proportion of structured products that should be held in a portfolio, but official guidance suggests no more than 25%.
With structured products it is possible to diversify across different products, with varying maturities, counterparties and the indices they are based upon.
‘Structured products display the same risk/reward characteristics as any other investment’
A well balanced and risk managed portfolio should then only really be troubled in the event of a catastrophic failure of the banking system, to which few investments would be immune, and then there is the opportunity cost of missing out if the FTSE 100 should into the stratosphere because of the limited upside offered by some products.
Because of the wide variety of products that are available, structured deposits may appeal to many types of investor in different circumstances.
Structured deposits could offer anyone other than those totally wedded to staying in cash the potential to link their returns to something other than interest rates, which look set to remain at rock bottom for some time yet.
A criticism could be that structured products are linked to the level of stock markets without dividends included, whereas equity tracker funds include dividends, but some pay an income in years when the FTSE 100 or other index is above a set level.
For investors seeking growth rather than income, structured products can save tax because most deliver returns as capital gains rather than income and for most people, tax on capital gains will be lower or non-existent and the timing of returns is certain.
Structured products may appeal to those accumulating a pension pot as longer dated products may have additional benefits built in and can be used to build value over time; shorter-term products may appeal to those already in retirements and looking for predictable returns.