December 2007

Structuring retirement

A major attraction of structured products is that they can be linked to pretty much any underlying asset class (equities, bonds, property, commodities etc) with the returns tailored to suit a particular investment outlook. So if an investment adviser believes UK commercial property is unlikely to continue its meteoric growth, they may feel now is a good time to protect gains already made and switch into a capital protected product (ideally one that delivers 100% exposure to the total return from UK commercial property).

It's also possible for fund managers (with some help from an investment bank) to develop capital protected versions of existing funds. The terms and cost-effectiveness of this will vary according to the type of assets held within the fund, but it is becoming an increasingly popular path for asset management companies keen to meet client demand. It is worth remembering, however, that developing product solutions like this only works with large investments.

Structured products not only provide a full selection of investment choices, they are also ideal for managing future liabilities as they deliver finite returns at a fixed point in time. This is useful both pre-retirement, when advisers can manage investment maturities to meet the retirement date, and also post-retirement if a drawdown strategy has been implemented and advisers are working towards a final vesting date.

Investments can be made that allow for preset amounts to be taken each year to meet investors' annual drawdown requirements. Alternatively, investments can be structured to generate a high income with a predetermined level of capital at risk.

Liquidity can be better than traditional investments

Historically, retail structured products have been designed for investors to buy and hold until maturity - cash-in values were generally considered poor. However, the introduction of the UCITS III framework and a general increase in institutional investment, have seen liquidity in structured products improve dramatically. Most products now offer liquidity at least as often as weekly, with many offering intra-day pricing. Secondary market prices are good and bid-offer spreads are typically no more than 0.5-1%.

This liquidity is critical for advisers, not only because it allows money to be vested as and when required but also because it makes the whole valuation process easier. Many prices are available electronically and some products sit on a number of wrap platforms.

There are also times when a structured product will deliver better liquidity than its traditional counterpart. Property investment is a fine example of this. It's not easy to sell properties (commercial or otherwise) in a flat or falling market, and certainly not easy to sell them quickly to meet redemptions from a property fund. As a result of this, most property funds operate with the ability to make investors wait for up to six months to redeem their investments. This is not only problematic in terms of timing for pension trustees, but it usually means you're sitting there watching the value of your investment fall without being able to do anything about it. A structured product, on the other hand, will always offer liquidity.

Enhanced participation addresses dividend argument

One criticism levelled at structured products is that investors forego the dividends they would have received had they bought the underlying investments directly. Obviously this argument needs to take in the nature of the particular asset class concerned, but normally this is a criticism levelled at equity-linked investments. This can be frustrating for product providers as it normally only takes a couple of simple sums to compare the structured product with the traditional alternative and work out the growth rates at which the strategies are better or worse than each other.

The economics should be easy to understand (see box above) with investors having to decide whether they want extra participation in the growth of the underlying asset, coupled with capital protection, or 100% participation in the growth plus the dividend income (minus charges and tax) and no capital protection. The enhanced participation and lack of any tax or charge "friction" means the structured product solution can often outperform the traditional approach, even at modest growth rates.

Obviously the equation is different for different structures, but it should be easy to make a simple comparison with a non-structured alternative. This exercise can also give an intuitive guide to a product's value, and if the non-structured solution only performs better at lower-than-cash growth rates, it raises the question as to whether it's worth investing in that asset class at all!

Drawdown clients not forgotten

Advising clients to defer annuity purchase and draw an income from their pension fund can be a minefield. Advisers want to avoid future mis-selling liabilities, at the same time as delivering investment recommendations that generate attractive returns. Using structured products can help to deliver certainty on capital returns, and still deliver high, equity-based returns. The products are a lot easier to explain than with-profit funds (they're also a lot cheaper).

Something for everyone and easy to find

Structured products have come of age in the last couple of years and have wide institutional and retail acceptance. The attraction of simple products, with clearly defined terms can benefit client and adviser alike, both in terms of delivering attractive, predictable returns and because they should be a "safe" sale, with little room for clients to claim they didn't understand how the investment worked. It's easy to research structured products with two excellent, web-based research services (www.futurevc.co.uk and www.srpadviser.co.uk) providing full product details, independent reviews and market news.

Clive Moore
Managing Director
IDaD