As the structured product market has evolved, the split between the different types of products has shifted around over the years. As pricing and market conditions change, structured product providers have the challenge of finding attractive return profiles for advisers and investors.
The largest proportion of structured products offered through the adviser space have always linked to the FTSE 100. Financial advisers and investors feel comfortable buying a product linked to the largest companies in the UK stockmarket. In 2009, stockmarket volatility and the banks’ appetite for funds was such that attractive returns could be offered by simply linking to the FTSE 100.
The same attractive conditions for structured product pricing haven’t existed again until more recently. It’s only recently that we’ve seen FTSE 100 single linked plans offering more than 10 per cent again – a function of recent volatility.
The increase in dual index-linked plans, especially over the past two years, is perhaps a function of chasing higher rates. A FTSE 100 only linked plan might have offered insufficient returns and so more risk was added to create attractive potential returns.
There has also been a rise in the number of products where performance is linked to a basket of stocks over the past few years. This could be a function of the pricing environment for structured products, with low volatility, relative to historical levels, and low bank funding rates, which means there is less money to buy options and therefore the payoff potential of a structured product.
Introducing new underlying measurements to the mix, beyond the FTSE 100, involves raising risk levels to increase headline rates. It will be more difficult to achieve a coupon on a structured product with multiple measurements, as you need two (or more) of these to achieve a given level, rather than just one. This is often referred to as a ‘worst of’, meaning that performance is determined by the worst performing asset on the given dates.
It’s easy to see how this can go wrong — auto-calls linked to shares such as Tesco or Glencore did not mature this quarter, as these shares are nowhere near their starting level. Indeed some plans linked to these shares risk maturing with a loss, as the share prices have more than halved in value over the term. If they finish more than 50 per cent down at their final maturity date, capital will be lost in line with the fall in the share price.
It’s hard to envision what will happen in years to come with specific companies, even if they are FTSE 100 businesses, meaning share-linked plans offer higher potential returns, but also higher potential losses.
A factor to consider when looking at dual or triple index plans is the correlation between the different measurements.
If the correlation is high, such as between the FTSE 100 and S&P 500, then including two or three indices in a product rather than just one may be a good way to improve potential returns without a big hike in the risk of losing capital. The underlying measurements are more likely to move together and so a significant amount of risk is arguably not added compared to investing in a single index product.
For these reasons, each structured product needs to be analysed on its individual terms to ensure that investors understand where higher headline rates are coming from and that higher potential gains are not negated by a lower probability of returns.