By Stuart Ritchie
If you follow me on social media or keep up with my blogs… You’ll know I often talk about the dangers of structured products.
My stance frequently riles up investors and financial advisers who “firmly believe” in their benefits. But these people are wrong. The risks that come with structured products far outweigh their benefits. Let me explain…
One of my LinkedIn connections messaged me. A financial “adviser” named John, wrote:
“Why are you so dead-set against structured products? There’s nothing wrong with them! I have numerous clients invested in them.”
Interesting to see him mention how many clients he has, yet he fails to truly substantiate his opinion. I couldn’t ignore the message so I went on to back up my findings – It turned out to be quite a lengthy message.
Days later, he’s read it but not responded and I’m hardly surprised. It would be very difficult (if not impossible) for him to find the evidence to prove me wrong.
As an investor and a financial planner, I am aware of the market’s volatility and how investors may lean towards “safer” products. Products that “guarantee” better returns and will protect them when the markets are down. Structured products seem to offer the best of both worlds… this idea is further promoted and pushed by those selling them, like the relationship manager at your bank, for example.
But be warned, these products are opaque and complicated. They are sold to millions of investors in Europe alone, raking in billions of dollars or pounds for banks and financial salespeople.
Ticking time bomb
Here’s the problem with structured products, as I told John:
- They are complicated and not always designed to be in the best interests of investors.
- The risk/reward ratio is simply poor.
- The illustrations and examples provided by investment banks always highlight and exaggerate the best features, while downplaying the limitations and disadvantages.
- The truth is that on a historical basis, the downside protection of these notes is limited, and at the same time, the upside potential is capped.
To put that into perspective, let’s say this particular product is linked to the S&P 500, offers a 10% buffer in a market downtown and 24% capped returns.
In 2008 when the index had -37% returns, investors suffered a loss of 27%… Which sounds like a good deal until you realise in 2009 when the index returned 26%, investors missed out on 2% growth that year.
Then in 2013 they missed out on a further 8% growth when the market’s return was 32%. Suddenly that 10% buffer weighed up against the 10% growth they missed out on… Doesn’t seem like such a great benefit after all.
Now add the fact that there are no dividends to help ease the pain of a decline… And you can see why I don’t believe structured products make wise investments.
No one knows how structured products work
Most people who sell them don’t understand them, let alone investors.I recently spoke to one investor who was left devastated in 2018 after learning that an expected return of 65% on a five-year structured product from Citibank was actually only going to achieve 21%.
Having reached a certain level in year one, the product “automatically exchanged” into a capital guaranteed product, earning interest of 2% per year.
So, while Citibank got to trade with the client’s cash for the remaining four years, the client was unaware his money was languishing. What’s more…
During the term of the product, the two indices it was linked to – the FTSE 100 and S&P 500 – hit historic highs. A simple index fund would have paid out substantially more and at much lower cost.
While structured products seem popular due to word of mouth, ‘advice’ from friends or friendly sales calls, they can damage returns. And I’m not just saying that because it’s my opinion – there’s simply not enough evidence to prove otherwise.
However, should you choose structured products anyway… Be sure to investigate fees and costs, estimated value, maturity, whether or not there is a call feature, the payoff structure, tax implications and the credit worthiness of the issuer.
As an expat investor who wants to grow their capital and protect it, and live out their ideal future, you need to do your homework before investing in anything that seems opaque or confusing.
Stuart Ritchie is a Chartered Financial Planner, APFS, Chartered Wealth Manager, and Chartered FCSI. Stuart works for AES International, a firm based in Dubai who specialise in helping ex pats to invest.