Structured Products

We've never seen a structured product that we would consider buying for ourselves. But if you must do it, read on..........

What are they?

These go under a number of names: "Guaranteed Products", "Guaranteed Bonds", "Guaranteed Equity Bonds", "High Income Bonds", "Structured Bonds" among them. These are products that are varied in their detail but usually involve a fixed term deposit with returns of both income and capital subject to (often complex) formulae.

Many of these bonds are high risk. The word "bond" has a comforting ring to it but these products can be Venus Fly-traps. For example, the delightfully-named "precipice bonds" offer higher returns in exchange for accelerated capital risk (things appear to be fine until you fall off the precipice).

They can only be sold through IFAs and have a limited investment window (maybe one or two months from launch). This helps to protect unsuitable products from independent analysis until it's too late.

What to watch out for

• These are high-commission products. Are you sure your IFA is giving you advice and not selling you a product?
• They may offer 'participation in equities'. This almost never includes receipt of the dividends that genuine participation would provide. This loses you about 3% per annum (which is the dividend yield in current markets).
• Ignore headline returns. In one product that we saw, returns of "up to 60% over five years" turned out to offer a chance of about one in a million of making the headline rate.
• Examine how the closing index is measured. One product that offered "participation in growth over three years" turned out to average the index over the whole three years - in effect only giving 1.5 years.
• Be suspicious of special indexes. They can be tailored to serve the interests of the provider. There's a whole industry out there that does this.
• Be honest: do you really understand the extent to which you are insulated from the risks of the complex derivatives carried by the strange overseas corporation (based in Dublin or Luxembourg) which is 'guaranteeing' your return? Notice that the big-name providers are always very careful not to guarantee the returns directly. These things could go bust (and have done in the past!) 
• Understand the biological biases that might be (mis)-guiding you to chose this product
• Have you evaluated hidden rare events?
• Read and understand the small print.

Above all, recognise the realities of the transaction. Once a provider takes your money in exchange for a set of promises about future payments (periodic plus return of capital), its interests are best served (and its profits maximised) by making those promises as unproductive as possible (for you). They'll do well when you get less. That's what is behind the complex formulae of these products prepared by people who are cleverer than you.

Regulation

The regulator periodically comes out with advice against subsets of these bonds. They warned against precipice bonds, but not in strong enough terms that actually stopped people buying them. They also warned against another variant called "High Income Bonds". These offered high guaranteed income by putting your capital at risk, a pointless exercise which might be described as "anti-insurance". Both these types of bond are still available, under different names.

Our advice

Junk.