Bloomsbury Financial Planning

As shares march higher, more structured products offering capital protection are being launched – but some advisers are refusing to recommend them. The reason is that advisers and investors are haunted by the battering these investment vehicles endured following last September’s collapse of Lehman Brothers.

Among the new products on offer are Investec’s three-year FTSE 100 Plan 10, which tracks the FTSE 100 and guarantees a return of 100 per cent of capital at maturity plus a 25 per cent bonus return if the final index level is higher than the starting level; Abbey International’s income accelerator account tracking the FTSE 100, Dow Jones Eurostoxx50 and S&P500; and Skandia’s protected Global Vista Fund, which is linked to the performance of a fund portfolio that includes Axa Framlington Emerging Markets and Henderson’s European Opportunities funds.

Alex Reynolds, a research analyst with Structured- retailproducts.com, which tracks the sector’s issuance figures, claims the number of new products being launched has surged since the start of the year.

But recollections of the losses that investors in Lehman-backed structured products suffered linger a year after the Wall Street bank’s bankruptcy. Many advisers criticise their high fees, counterparty risk and lack of transparency.

“Most structured products I’ve seen are, in my personal opinion, a terrible ‘punt’,” warns Jason Butler, an adviser with Bloomsbury Financial Planning.

“I dislike these products as the one certainty is that the issuing institution is making a handy margin out of it. As we’ve seen with Lehman Brothers, these products are only as good as the counterparty underpinning them. Someone has to pay for that ‘protection’, and guess who that is?”

The bankruptcy of Lehman Brothers last year showcased the dangers of the counterparty risk these vehicles carry. While the equity-linked returns offered by structured products come from option contracts on an index, the capital guarantee is provided by bank debt instruments. Structured products often balance their risk by buying medium-term notes – listed corporate bonds – from other banks that can guarantee products. So, investors who bought structured products where Lehman was the counterparty incurred serious losses when the bank defaulted on its obligations.

The Financial Services Authority is currently investigating the sales literature and practices across the structured product industry.

The failure of Lehman-backed structured products has prompted advisers to encourage clients to pay attention to the creditworthiness of the institution backing a product as well as the fees, costs and level of market volatility.

Creditworthiness is of upmost importance at a time when the financial soundness of some banks is still being questioned. A structured product’s net asset value will be reduced if the bank backing the structured product is derated, analysts at WINS Research claim.