Cash Clinic: Structured products are not without risk

Q I AM considering buying a structured product from my bank, but have heard very mixed reviews.

Could you advise me on the benefits and pitfalls of such so-called capital guarantee products?

AB, Dundee

A STRUCTURED products are market-linked investments that aim to provide specific returns and can offer investors capital protection at maturity. Cashing in a structured product early can result in the return being below the sum of the original outlay. .

Market-linked refers to the index or basket of indices that the product's performance is pegged against and investors can receive a range of set returns reflecting the movements of the underlying index.

Structured products tend to be made up by two component parts: a cash or near-cash investment which aims to provide a full capital return at the end of the term, and a speculative investment vehicle to generate the investment return.

The investment date is known as the strike date. The strike rate is the index value at that date, which the product's performance will be linked to.

The main difference between structured products and investing directly in shares from the underlying index is that investors are not entitled to dividends or the benefits of corporate actions. The dividend income is paid to the provider.

An element of capital protection can be built in. Hard protection defines how much of the original investment in percentage terms is at risk, and provides a cap on the maximum loss an investor can incur irrespective of the underlying index performance.

Soft protection identifies the percentage change to the underlying index that needs to occur before the capital is at risk; 50 per cent soft protection indicates that the investment capital is protected until the underlying index drops below 50 per cent.

In any event, and notwithstanding the guarantees, it is important not to invest too much into a structured product. They should only ever complement an overall investment strategy.

Counterparty risk remains associated with structured products. In the event that the third party defaults, the investor's guarantee cannot be met and they may lose up to 100 per cent loss of capital. Most structured investment products do not have Financial Services Compensation Scheme (FSCS) cover, and while the probability of counterparty failure may be low, this means the impact of a default could be catastrophic. It is important to note that structured products are not guaranteed.

Structured investment products, where there is no FSCS protection, are not suitable if you do not want to risk any loss of capital.

• Christian Poziemski is a wealth manager within the private client and financial services department of HBJ Gateley Wareing

If you have a question you need answered, write to Jeff Salway, The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or e-mail: [email protected].

The above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and HBJ Gateley Wareing accept no liability on the basis of this article.