What is it?
Structured products is the name given to a group of investments that are designed to deliver a known return for given investment circumstances and combine two or more underlying assets in order to offer growth or income potential whilst usually offering some degree of capital protection Such investments normally share the following characteristics:
- Fixed term which means they are not as liquid as deposit accounts or investments in equities.
- Linked to the performance of a stock market index/indices
- Offer enhanced returns because of additional risk assumed.
- Offer Growth or Income Options or both.
- Can be held within a variety of product wrappers including ISAs – many products allow ISA transfers.
- Varying degrees of capital protection may be available for example with maximum loss being defined at outset or full protection given in all but extreme market conditions.
- Tend to be offered for a limited period and for a limited amount of funds. The investment company will set a maximum amount that can be invested, once this level or the closing date is reached, the offer closes.
These products offer you growth that is linked to stock market performance – usually via an Index, such as the FTSE 100 Index, although the amount of return you can receive is sometimes capped.
Some structured products do expose your capital to risk, although these plans are often set up with a “safety net feature”, which means that the stock market can fall by a certain percentage without affecting your capital return.
Other structured products protect your capital and are designed to return your capital whatever happens to the stock markets, these generally offer lower rates of return. The rewards or potential rewards offered by Structured Products are usually closely linked to the level of risk you are prepared to take. Many products offer you a choice of income (monthly, quarterly, annually) or growth and this is often a fixed percentage in each case.
You should carefully assess the potential rewards against the risks. For example, you may be offered a fixed income for a period of time but with the risk of losing some of your capital. Or you may be offered capital security with lower potential returns.
The “safer” a plan is, the lower the potential rewards tend to be and the reverse also tends to be true. It is important to remember that you might get more by investing directly in the stock market if it is a rising market although you would not get any protection from any falls.
The counterparty issues financial instruments and assets which are intended to deliver the investment returns for the structured product.
Your money is invested in a Medium Term Note which is a type of Corporate Bond, which is a loan to a company. The company we’ve selected to buy the Notes (the Note Provider) is financially strong. However, there is a possibility that the company could fail. In the unlikely event that the Note Provider defaults or becomes insolvent, your investment would be at risk and you could lose some or all of your investment.’
The Medium Term Notes are provided by a company that is rated ‘AA’ by Standard & Poor’s Ltd. Companies are rated from AAA (Most Secure/Best) to D (Most Risky/Worst) by this independent agency. Based on this rating, Firm A believes that Firm B is likely to repay its debts at the end of the term of this Plan, but this is not guaranteed.’
Capital Risk At Maturity
Some structured products include a form of capital protection. Generally there are two types of protection available as follows:
- Hard Protection where the minimum return is fixed regardless of the underlying investment performance.
- Soft Protection where the minimum return will only be achieved if the underlying investment maintains a certain level. If it does not, the capital protection may be lost in part or completely.
The capital protection often takes the form of a Bond from the financial counterparty to the structured product and this is usually an Investment Bank or some other form of large financial institution. The strength of the protection will depend on the counterparty’s ability to meet its financial obligations at the end of the investment term of the structured product. Assessment of the counterparty is based on a number of factors which include credit worthiness (using independent credit ratings) and financial analysis (e.g. Financial Statements and Financial Ratios) as well as assessment of management (experience and commitment) and market opinion.
Structured products are generally a type of fixed-term investment where the amount you earn depends on the performance of a specific market (such as the FTSE 100) or specific assets (such as shares in individual companies).
There are two main types of structured product:
- Structured deposit
- Structured investment
Some structured investments offer a degree of capital protection while others do not. The income or growth is usually not guaranteed and you may get no return on your investment. Even where there is capital protection, the deduction of fees and charges could mean you could get less than you put in, particularly if terminated early.
Structured deposits and structured investment products with some capital protection are often purchased by those looking for alternatives to saving accounts and other deposit-based products.
Structured deposits – Structured deposits are savings accounts, offered from time to time by banks, building societies and National Savings & Investments, where the rate of interest you get depends on how the stock market index or other measure performs. If the stock market index falls, you are unlikely get any interest.
Structured deposits generally require you to tie up your money for a set time, often five or six years in return for a lump sum at maturity. The amount you earn depends on how well something else performs – often a stock market index such as the FTSE 100.
Structured investments – Structured investments are commonly offered by insurance companies and banks. Your money typically buys two underlying investments, one to protect your capital and another to provide the bonus. The return you get depends on how the stock market index or other measure performs.
When you buy a structured investment, you also agree to tie up your money for a set period. Some of these products offer you a lump sum at maturity depending on the performance of the stock market index or other measure.
Other structured investments let you take a regular income and whether or not you get back your original investment in full depends on how the stock market index or other measure has performed. If the stock market falls, you can lose a very large chunk of your original investment.
The majority of structured products offer three ways of investing into the plan:
- Direct investment – you invest capital into the plan.
- ISA – you invest into the plan within an ISA wrapper and receive the same tax benefits you would by investing in an ISA.
- ISA transfer.
In addition, some plans also offer an option to invest via a designated pension wrapper such as a Self- Invested Personal Pension.
There are no specific limits on the level of investment other than those that may apply to the wrapper (i.e. ISA or SIPP) for the investment. Also, providers may set their own minimum levels of investment per application.
Normal tax considerations apply where held outside of a tax wrapper e.g. ISA or pension plan.
Most growth plans are designed such that the investor may have a CGT liability at maturity but they could of course still make use of their Annual Exempt Allowance. Any excess returns would be subject to CGT at 10% for basic rate tax payers, 20% for higher rate or additional rate tax payers. Any losses can be netted against other gains for the tax year.
Returns from income plans are normally subject to income tax. The income distributed may be gross or net of basic rate tax depending on how the plan is structured.
Income from the corporate bond is paid gross of tax. Taxpayers who invest outside of an ISA will be liable to pay income tax at their highest marginal rate, usually via their annual tax return.
Non taxpayers, after addition of the income from the bond, should have no tax liability.
From 6th April 2016 all individuals have a £5,000 per annum dividend allowance and dividends up to this level are tax free. Dividends over £5,000 are taxed at:
- 7.5% on dividend income within the basic rate band
- 32.5% on dividend income within the higher rate band
- 38.1% on dividend income within the additional rate band
If the investment is within the ISA option, income is free of taxation.
You should not invest in this plan if you might need access to your funds during the term of the plan. If you do encash the investment prior to maturity, heavy penalties will be incurred and you will receive back significantly less than you have invested.
Although the products are intended to be held until maturity, investors may be able to access their investment during the term of the product through a secondary market. This will enable them to recover something approaching the market value of their investment although this may be less than the amount they invested.
However, some plans aim to generate an annual income, however this is not guaranteed, other than in the first year of investment, and is dependent on the performance of the relevant index e.g. FTSE 100.
Often criteria such as this will apply:
- The first annual coupon is paid on the first anniversary of the investment, regardless of how the index has performed.
- Thereafter, the coupon will be paid on an annual basis only if the Index Level has not fallen by 50% or more, from the Initial Index Level, when measured on the annual observation date. If the index has fallen by 50% or more, from the Initial Index Level no coupon is paid.
- If the Index Level is the same as or higher than the Initial Index Level, on the annual observation date, then a “Lock - in event” occurs. This means that the annual coupon is fixed until maturity.
There are a number of risk considerations that need to be taken into account. It is important that you are aware of these in relation to your particular circumstances.
You must be prepared to accept some risk to your capital to achieve these returns. You should not enter into the transaction unless you are prepared to lose some or all of the money you have invested.
- This Plan is not like a deposit account. It offers the potential of growth or annual income, and repayment of your capital is not guaranteed. The capital invested is not protected as it depends on the performance of the relevant index. This means that you could lose some or all of the capital you invest.
- I have made you aware that the perceived creditworthiness of the issuer [Bank] may affect the market value over the term. Furthermore if the issuer [Bank] fails to meet its obligations you may get back less than is due to you or nothing at all. The income payments may also be affected.
- You understand that, as the product is linked to an index, the underlying index may fall significantly at the end of the term resulting in you suffering a financial loss and that there is no facility to manage the investment to reduce exposure to falling markets.
- You do not need access to your money for the term of the Plan but if you are forced to realise your investment before maturity you may get back less than the amount you originally invested. You must be aware that this is a fixed-term product that cannot be cashed in according to market sentiment.
- The closing level of the relevant index is calculated on a capital return basis. It does not take dividends into account.
- Past performance is no guarantee of future returns, and the Final Index Level of the relevant index may be lower than the Initial Index Level.
- Inflation will reduce what you can buy in the future.
- The tax treatment of the Plan could change at any time.
- The price of units and the income from them can fall as well as rise.