TOO much choice can be a problem for investors these days. Online consumer champion Which? singled out structured products as being some of the most confusing instruments on offer and was particularly unhappy about their lack of transparency, particularly when it comes to counterparty risk. The UK Structured Products Association hit back at the research saying that listed products are regulated by the FSA and praising the standard of educational material produced by the providers. This argument doesn’t exactly help investors who are trying to find returns in an environment of low interest rates. So to help our readers, we have looked in depth at some of these products to de-bunk some myths and figure out what the lingo actually means. These products are complex, but not impossible for a retail investor to understand.
IN FOCUS | EXCHANGE-TRADED NOTES (ETN)
Barclays launched the first ETNs listed on the London Stock Exchange earlier this year. An ETN is actually a promise of an issuer (say Barclays) to pay the value of a specified index minus any fees to the owner. Uwe Becker of Barclays says that the chief attraction of an ETN, as opposed to an ETF, is that there is no tracking error. An ETF is created by a provider to mimic the actual index and sometimes there are slight slippages. An ETN is different – the provider owes the holder of the note the performance of the index, irrespective of whether they hedge themselves or not. The risk is that you have to rely on the fact that the issuer, such as Barclays, is able to pay you at any time you choose to redeem your ETN. The benefit is that they give you access to a wide range of markets such as commodity indices.
IN FOCUS | UK DEFENSIVE AUTOCALL
This product is available from RBS and isn’t nearly as scary as it sounds. But it is a long-term investment. The life of the product is five years and each year has a trigger point, which, if reached, adds a 6.75 per cent “coupon” to your final payout. For example, in the first year if the FTSE 100 is equal to or above 80 per cent of the starting level, then it automatically redeems early and you would receive 6.75 per cent plus your original investment. If on the final valuation date the index is at or above 60 per cent of the level when the product was issued, then you will receive 33.75 per cent of the total issue price, plus 100 per cent of your original investment. But if the FTSE is trading at 59 per cent of your entry level, then you would only receive 59 per cent of your original investment.
IN FOCUS | SYNTHETIC ZERO
These products have been knocking around for a while and are popular in Europe. Now the UK is catching on too. RBS offers a Synthetic Zero on the FTSE 100. It’s also a long-term investment and expiry date is six years. It will pay you 9.25 per cent for every year that the FTSE 100 is 50 per cent higher than your entry level. What is good about this product that the 50 per cent level is constant throughout its lifetime, so you win as long as the index is 50 per cent higher than your entry level – it doesn’t scale higher each year. Societe Generale also has a large selection of Synthetic Zero products that track a wide variety of indices and stocks, including mining giants Rio Tinto and BHP Billiton, with a variety of strike prices.
IN FOCUS | EXCHANGE-TRADED FUNDS (ETFS)
These tend to track an underlying index, such as the FTSE or the S&P 500. The beauty of an ETF is two-fold: first you pay low fees to get exposure to an entire index compared to buying each individual stock through a broker; second, you can buy short ETFs, so if you think the FTSE will fall in the coming weeks, then you could use an ETF to take a short position. The issuer tries to mimic the underlying index, but be aware that sometimes the issuer’s portfolio can slightly slip out of line with the underlying index, which is called a tracking error. You receive the performance of the issuer’s portfolio, so the tracking error is important. You need the issuer to remain solvent but your investment is backed by an actual portfolio of assets unlike an ETN.