Structured products are still best avoided

by Ed Bowsher on 03 April 2012  |  3 comments
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A return of 7.2% a year on your capital sounds good, but it comes from a structured product so I'm not going to invest.

Halifax has just launched a new savings product called the Income Generator 2. If you’re able to invest for a five-year term, you could be paid a fixed annual income of 7.2% and you’ll probably get your initial capital back at the end of the term. 

In a world where stock markets have performed poorly for the last ten years and where the top-paying savings accounts are offering around 4.5% a year, that looks, at first glance, like a pretty good deal. So how does it work? 

The Income Generator 2 is a ‘structured product.’ That means your investment return is determined by the performance of an asset, but you’re not investing directly in the asset yourself. 

So you might invest in a structured product that was linked to coffee. The deal might be that if the coffee price fell, you wouldn’t lose any money, and if the coffee price rose by 10%, you’d get a 5% gain. So your investment return would be linked to the price of coffee but you wouldn’t own any actual coffee. (This is an imaginary product I’m writing about here.) 

Guarantee 

Most structured products are complex and are aimed at professional investors, but there are some available for ordinary investors. They’re normally marketed as ‘guaranteed’ or ‘protected’ products and are linked to the FTSE 100. 

Here’s how the Income Generator 2 works. Let’s say you invest £5,000. Your money is now locked away for five years and you’ll receive £360 in income each year. The income won’t be reinvested, so no compound interest applies.  

At the end of the five year period, you’ll probably get your £5,000 back. There are only two scenarios where you won’t get all of your money back: 

- The FTSE 100 falls by more than 50% over the five year period. If the FTSE 100 falls by 55%, you’ll lose 55% of your capital. But if the FTSE 100 falls by 45%, you’ll get all of your £5,000 investment back. 

- Lloyds Banking Group, which owns Halifax, goes bust. The Income Generator product isn’t protected by the Financial Services Compensation Scheme (FSCS). 

This table shows how much money you might make in different situations: 

If you need your money back early, Halifax will be willing to buy you out assuming ‘normal market conditions’ apply. However, the price will be set by Halifax, and it may well be less than £5,000. The offer closes on April 16th so you need to make your investment by then. The five-year term will begin on April 18th 2012 and end on April 18th 2017. 

So are you tempted to sign up? Let’s look at the pros and cons: 

Pros 

- 7.2% is a much bigger return than you could get from a savings account.

- The risk is fairly small. If the FTSE 100 falls 25% over five years, you’ll still get all your capital back. The chances of the FTSE 100 falling by more than 50% over five years are low, but not impossible.

- Can go in an ISA or SIPP.

- Halifax takes its cut before it pays the 7.2% income is paid so there are no charges apart from a monthly 0.05% charge if you make your investment within an ISA. 

Cons 

- Over the long-term, the stock market has typically produced an annual return of 11% a year. That return comprises dividend payouts and rising share prices. There’s a good chance that you’ll make more money if you invest directly in the stock market rather than Income Generator 2.

- Your money is locked away for five years. If you need your money early, you may not get all of your money back. Or possibly none at all.

- No coverage by the FSCS. There’s a risk you could lose out completely if Lloyds went bust. If you think that can’t happen, read 1700 cheated Lehman savers will receive compensation.

- The product isn’t transparent. Halifax will be investing your money in complex instruments that few people understand properly. If you don’t understand what you’re investing in, you probably shouldn’t invest. 

My view 

I’ve always been very negative about structured products. The risks are normally greater than many realise while the returns are often disappointing. 

I think Halifax’s product is better than many because the 7.2% income is so high and the risks are relatively small. That said, I still won’t be investing myself. 

After ten years of rotten performance I think shares now look pretty cheap. There’s a good chance that the stock market will do pretty well over the next five years, so I really don’t see the need to protect myself from stock market falls. I reckon I can probably generate a bigger return than 7.2% a year. 

And even if the stock market does do badly over the next five years, I’m only 44, so there’s plenty of time for my investments to recover before I retire. 

So for me, I’m going to take my chances on the stock market. If you’re nearing retirement and worried about risk, I can see that the Income Generator 2 might be tempting. But if you’re worried about losing your money, why not take the lowest-risk option and put your money in a savings account? Sure, you’ll get less than 7.2% a year but you won’t have to worry at night. 

Structured products are still best avoided. 

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