I agree with the FSA!
The FSA is worried another mis-selling scandal may be brewing.
The FSA has said this week that it’s becoming concerned about an increasingly popular type of investment vehicle – the structured product. It’s worried that there’s potential for mis-selling. I agree.
So what are structured products?
At first glance, structured products look great. In theory, they enable you to get a decent return on your savings if the stock market performs well whilst not exposing you to too much risk.
The Legal & General Growth Plan 3 is a typical example. You lock your money away for five years and if the FTSE 100 index rises or stays level over that period, you get your initial investment plus 55% back.
After five years, if the FTSE 100 has fallen by any amount up to 50%, you get your initial investment back with nothing more.
And if the stock market falls by more than 50%, you’ll get your initial investment back minus the fall in the stock market. So if the FTSE 100 falls by 60%, you’ll get 40% of your initial investment back.
There are four main problems with this product:
- You lose flexibility. Your money is locked away for five years
- If we have a really massive stock market crash, you won’t be protected. Such a big crash is very unlikely but you can’t completely rule it out
- If the stock market does really well, you’ll only get a 55% return or an annual return of roughly 9%. That’s not to be sniffed at, but it doesn’t match the long-term historic return from shares which is closer to 11% a year. So there’s a decent chance you might do better if you invested directly in the stock market via an index tracker fund
- This product is hard to understand. As a general rule of thumb, complex products are best avoided
The reputation of structured products was also tarnished in the aftermath of the financial crisis. Investors in several products that were linked to Lehman Brothers had a very scary year as they feared they might lose all their investment.
Thankfully, the FSA rose to the occasion and the investors got full compensation, but, in my view, the episode just highlighted the risk that comes with these products.
And it’s now clear that the FSA also has some concerns about these products. Between November 2010 and May 2011 the regulator reviewed seven major providers of structured products that amount to about half of the market.
As a result of that review, the FSA has highlighted some problems and says it’s worried that the increasing complexity of these products may be storing up problems for the future. It’s also worried that the growing popularity of structured products may put a strain on firms’ systems and controls.
The regulator says that the industry should improve in several areas, I’ll highlight two. Firms should:
- identify the target audience and then design products that meet the target audience’s needs rather than merely contributing towards the firm’s bottom line
- stress-test new products to ensure they are capable of delivering fair outcomes for the target audience
That’s pretty trenchant criticism from a regulator. To be clear, I’m not suggesting that all providers of structured products are solely focused on their bottom line, but I suspect that many of them are. And anyway, even if the provider isn’t solely focused on profit, these products are still best avoided.
I also fear that some financial advisers may push these products to clients for whom the product really isn’t appropriate. The FSA plans to investigate how these plans are being sold next year. Let’s hope they don’t find too much dodginess.