It sounds counter-intuitive, but there are good reasons why it’s happening, says Ian Lowes, MD of Lowes Financial Management and Founder of StructuredProductReview.com.
Financial Services is an ever-changing landscape, constantly shifting with the socio-economic conditions of the time. Taking the ‘glass half empty’ approach, many of these changes can be a source of frustration – and to be honest, there are few of them that we have any real individual control over. I’m sure most of us have experienced more than a little disruption over the previous years as markets have crashed and recovered. However, not all of these changes are bad, and even in the worst environments there have been some fantastic opportunities for investors.
So, for the purposes of this article, I would like to take a much more neutral view, and just take a snapshot of where the UK retail structured product market currently sits in relation to five years ago. And also to think about how those products that have matured in the first quarter of this year (that is, were launched as far back as 2008) have performed.
Structured products are a relatively late entrant to the UK retail investment market, so you could say that a five-year period represents a significant portion of their ‘lives’ to date. And in that time, as you would expect, based at least in part on investor demand, the market has been shaped and moulded.
At the same time, the pricing of structured products themselves is based on a variety of factors – notably the volatility in the underlying measurement and the financial strength of the counterparty to the investment.
And of course, the position and movement of the underlying index can also change what investors consider to be ‘good value’. Given that structured products have a limited offer period, and that new products coming to market will inevitably reflect the historic conditions at that time, it is possible to trace strong themes and trends, both in respect of the general terms on offer and in respect of the most prevalent product types and payoff shapes.
‘Capital Protected’ Products in Decline
The first, and probably most obvious, shift in focus of the structured product market between 2009 and today is the significant reduction in the numbers of capital ‘protected’ products and the increase in capital-at-risk. Back in 2009, almost 23% of the structured products launched in the IFA distributed UK retail space were capital ‘protected’ products. By 2013, this figure had fallen to just 2.5%, and so far in 2014 they only represent around 1.6% of the products that have been offered.
Fewer Structured Deposits
The proportion of products that are structured deposits has also fallen, albeit not quite so dramatically, from 28.5% in 2009 to 17.75% in 2013 and 14.06% so far in 2014. In contrast, just under half of the products that were launched in 2009 were capital at risk products, a figure that is over 84% to date in 2014.
Does that Mean Risk is Being Accepted?
Does this mean that investors are becoming increasingly comfortable with risk? Maybe. But, perhaps more pertinently, pricing conditions have changed dramatically during that period – and recently it simply has not been possible for capital ‘protected’ products and structured deposits to offer the same level of potential returns that they did back in 2009. Consequently, these sorts of products are less likely to garner interest from investors, so the natural balance of ‘supply and demand’ has shifted the focus away from this end of the risk spectrum.
It’s All In The Returns
The balance of risk and reward comes across very clearly in the returns that IFA-distributed structured products generated in the first quarter of 2014. Somewhat surprisingly, overall structured deposits outperformed capital ‘protected’ products, returning an average annualized gain of 4.94% against 4.50%.
The pattern was, however, reversed in the best 25% of maturities of each product type, with the capital ‘protected’ products generating an average annualized gain of 8.95% against the 8.38% of the structured deposits. More expectedly, although nevertheless impressive, the average annualised return of capital-at-risk products was almost double those of the capital ‘protected’ products and structured deposits, standing at 9.01%, and the best 25% produced a notable 14.58% on an annualised basis.
So where are we now? Well, structured products certainly seem to be here to stay and, with the returns that they have been generating, alongside their varying elements of capital protection, I can only envisage an increasing number of investors viewing them as an important and beneficial element of their overall investment portfolio. Undoubtedly the UK retail structured product market will continue to develop and adapt to changing circumstances – and I for one am excited about being part of its evolution.