Know the risks before choosing 'structured'

Sales of structured products reached a record 13.3 billion in 2009 as low interest rates gave banks the opportunity to sell to customers unable to secure real returns from their savings. But there have also been mis-selling accusations and the Financial Services Authority warned earlier this year of a "significant risk of profound mismatches" between structured products and the needs of those investing in them.

The FSA's comments were supported by a recent mystery shopper exercise by consumer group Which. It sent researchers to 37 bank branches asking what they should do with 55,000 that was set to mature elsewhere, stipulating that they were risk-averse and approaching retirement. Almost two-thirds suggested structured products, and six recommended investment bonds, both of which involve stock market risk, while more than a third failed to point out that with the 55,000 investment exceeded the Financial Services Compensation Scheme limit of 50,000.

The other evidence of banks mis-selling unsuitable investments is more anecdotal but implies flagrant disregard for customers' needs. Patrick Connolly, spokesman for wealth managers AWD Chase de Vere, noted that structured products are considerably more lucrative for banks than traditional savings accounts.

"The problem is that while structured products may be easy to sell, they are not a core investment and should only be considered by those who already have a diversified investment portfolio and who understand and accept the risks involved," Connolly said. "Many bank customers will be elderly and rely on their savings in their retirement. These people are often very cautious simply because they cannot afford to lose their money, and so structured products and any other investments with risk attached are totally unsuitable for them."

Haig Bathgate, chief investment officer at Turcan Connell in Edinburgh, raised concerns over the charges embedded within structured products.

"We have analysed structures where the amount being extracted by large high street banks has been as high as 10 to 12 per cent," said Bathgate. "Unless you understand derivative pricing it is impossible to really understand how much you are paying.The banks, if ever cross-examined on this, would say that it's the cost of distribution, but to put it in context we are rarely charged more than 1 to 2 per cent."

Ian Lowes, managing director of Lowes Financial Management in Newcastle, concurred. Charges of between 9 and 12 per cent are common but reflected only in the return offered by the product and not made explicit, said Lowes, who runs www.comparestructuredproducts.com.

"If the charge was lower than 9 per cent, for example, then the deposit return would be higher," said Lowes. "If there was no charge, 100 per cent participation in the FTSE might be 110 per cent.

You don't know where the charges are going so you can only assess whether you are getting any value from it, compared to what you have given up to get that."

Structured products can be ideal for those seeking a compromise between conventional savings accounts and full equity exposure.

But it's worth shopping around and getting advice, given the massive range of product types, from the deposit-based plans on the high street to more sophisticated offerings from firms including Blue Sky Asset Management and Investec.

Banks accounted for the bulk of the 13.9bn of plans sold last year, with just 23 per cent made through IFAs. But while the basic premise is appealing and seemingly straightforward, the plans are often opaque and merit close scrutiny.

For example, a product sold in massive numbers by one Edinburgh-based bank has a clause allowing it to switch investors into cash when the market falls by a certain amount - but it keeps them there for the remainder of the term, even if the market rebounds.

Fraser Donaldson, insight analyst at researchers Defaqto, strongly advised taking financial advice when taking out a structured product. "It is always worth checking what else is on offer in what is a large and growing market. If you're going to invest in structured products the chances are that you have a lump sum that justifies going to an IFA," said Donaldson. "There are lots of elements to structured products, such as the counterparty risk, the participation, the index and the guarantee, so advice will be worth it."

Advice also protects savers from inappropriate marketing, said Bathgate. "In many cases they carry market risk as the underlying reference index is something like the FTSE 100. However, they are marketed like quasi term deposits in many cases or shown as a term deposit with an additional market exposure element," he said.

"Structured products are very suitable investments for most clients and we use them extensively. However, it is critical that consumers take advice from professionals that are not tied to one bank."