The complexity argument on structured products

Structured products may be complicated but charting their potential should be a simple process

Lowes-Ian-2010-700.jpg

It is generally assumed that if a derivative is used, it is a complex investment. Investor suitability is clearly important, but it has long been argued that the complexity of structured products makes them suitable only for sophisticated investors

At the Structured Products Europe conference in London in November, an official from the French regulator, Autorité des Marchés Financiers (AMF), made some interesting points about the ‘complexity’ argument in reference to structured products.

Guillaume Eliet, managing director of the AMF’s regulation policy and international affairs division, spoke about how complexity is not necessarily a negative and can add benefits and value. I can see his point.

For example, gearing in structured products can allow enhanced upside participation in the index above that of a traditional passive investment but without any downside gearing. The components of a structured product allow capital protection to be offered, which is highly valued by investors.

Rather than doing a complexity assessment, Eliet said the product should perhaps be considered on how intelligible and beneficial it is. For example, the iPhone is a complex piece of equipment, yet it is made as simple as possible to use. The options underneath a structured product may be complex, but understanding the potential outcomes and how they could be achieved is simple.

Just as an investment decision on a fund involves considering what performance could be in different market conditions, considering a structured product for investment involves mapping potential outcomes. But these are based on a fund manager’s opinion and actions, whereas the potential outcomes of a structured product are predefined. 

Advisers feel comfortable holding multi-strategy funds, such as Standard Life’s GARs fund, because the consistency of performance makes it a valuable addition to portfolios. The many strategies make it complex, but advisers do not feel the need to understand the detail of every single strategy operating in the fund.

A survey we did among registered users of the CompareStructuredProduct.com website asked them why they like structured products.

The most common reason was their defined returns, with 81.6 per cent of correspondents choosing this as one of the reasons why they like structured products. Known maturity dates were also a popular reason, with 54.4 per cent of users selecting this option; 42.1 per cent said they are easy to understand. I think this shows investors pick a structured product because the outcomes are easy to understand.

Everything, from a unit trust to a whole of life policy, is complex if you break it down to its components. An adviser’s job is to identify the key elements of the investment to assess the risk-reward trade-off and make a decision on its suitability for the client based on their attitude to risk.

While the outcome of one structured product may be easy to understand, holding many in a portfolio, while providing diversification, could cloud the transparency of outcomes. This is why, at Lowes, we lift the bonnet on the whole portfolio and use SP-Perspective, now available to StructuredProductReview.com users, to view how investments fit together. Counterparty exposure of a structured product portfolio can be assessed as a whole and notifications are given to help users keep the adviser informed and take appropriate action.

It is a myth that most of our client assets are invested in structured products: most are in active managed funds. But, for our passive exposure, structured products’ outcome focus and capital protection are valuable from an investment point of view.

Maybe there should be less focus on the ‘complexity’ argument and more on the intelligibility of actual outcomes.

Key takeaway The complexity of structured products does not necessarily make them suitable only for sophisticated investors. There should be less emphasis on their complexity and more on the intelligibility of outcomes.

investreturns

___________________

Ian Lowes, founder, StructuredProductReview.com