My Further Thoughts on Structured Product Investing

As a follow on to my last post I now understand Colm Fagan is concerned with the BCP Transatlantic Defensive Kick-Out Bond 5. Therefore I want to state I was part owner of BCP’s parent company but sold my interest and have not been employed by them for nearly 4 years. My intention is to encourage discussion in and the use of structured products as I believe many clients could be well served by investing part of their portfolio in them.

Here are my thoughts on that bond, some of which would apply to certain other structured product. As there are the many types of structured product it is not possible to generalise across all types.

1. An investment will not be accepted from a retail client unless they have taken professional advice. The advisor must complete his research which will then significantly reduce the possible of a client misunderstanding the investment.

2. The application form, as it must, looks for details on all previous investment experience of the client for the purpose of assessing the clients understanding, through experience. Regardless of what the client or their adviser proposes?BCP must still make its own assessment as to the appropriateness of the investment for each retail client. The CBI may review these applications. Again this is in part to help protect the client against any possible misunderstandings.

3. Before any new structured product is made available there is considerable energy and time spent protecting the client through the creation of all the documents, to help retail clients to only make fully informed decisions. Legal, compliance, and investment advisors must review all documentation before it is released to clients.

4. The information issued for the investment is very extensive and includes brochure, KID and training slides. The brochure is considered marketing material which is very detailed. For most clients it is the easiest document to follow. It does have to be accurate and contain all relevant information. However it is a long document in my view but I don’t see any way make it shorter. The KID document is generally a more difficult document for clients to understand. In my opinion is is not very clear to retail clients.

5. KID documents, as well as other MiFID documents have to follow strict legislation. These regulations are not very suitable when attempting to show possible investment outcome scenarios for structured product. For example in the scenarios detailed the Favourable Outcome indicates a loss over 1 year. If I understand the favourable column correctly the assumption is the client has encashed the investment outside of any possible maturity date. I would not describe this as a favourable outcome. Surely a favourable out come would have to demonstrate the return of capital with the contracted gain on the first anniversary.

6. This type of structure matures (kicks out) automatically along with gains and is paid back to the client if it reaches the required barrier. At the end of 5 years if the bond has not already matured the required barrier reduces by 15%.?This covers a considerable portion of the decrement deductions particularly when you factor back in the dividend yield earned over the period.

7. The front cover of the brochure states that this is a Capital at Risk investment. This statement is also included a number of times within. Again this should help the client understand this not with out risk.

8. Back testing can be helpful. It must use actual past performance for the underlying index as if it had existed including any deductions (e.g. decrement) or additions ( e.g. dividends). If there has been no loses then that’s the fact for that period. I would not make a decision based just on historic performance. What is more interesting I think are the “Examples of Possible Return Scenarios” on page 17.

9. In certain scenarios this bond can help provide a better return for the client than investing directly in the underlying assets while in other scenarios deductions will negatively affect the returns. That said a point that is not regularly understood is the underlying asset does not need to grow any where near the same level as a direct investment to get a similar return in many scenarios.

There are a number of other points but this post is already too long (hence my comments are in the form of a LinkedIn article). To conclude, yes there are risks and costs as with all investments. There are also benefits and processes in place some of which are not available in other investment options. These cannot be ignored and must be taken into account for a full assessment by the advisor on behalf of the client.

I probably should state for clarity that I am not currently regulated or employed by or advising any, structured product entity. I hope you find the above of interest.