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You are here:  FE Trustnet     Education        Structured Products

Structured Products


What do investors need to consider before buying a structured product?
Pros and cons
The benefit of structured products is that the range of underlying asset combinations available can accommodate an investor's view of the prospects for a particular asset or - for more complex investment strategies - mix of assets. Unlike traditional investment funds, with most structured products the investor is not exposed to a particular manager's style or ability. Also, investors will know how their upside participation is limited or enhanced by the terms of the offering and, in tandem with the degree of capital protection in the structure, the risk and return characteristics of the product will be both transparent and fixed.
Clearly, nobody likes to lose money, but after assessing the structured product's terms the investor can at least be certain of the best- and worst-case outcomes; the return may turn out to be disappointing, but at least nobody can say that they were unaware of the possibility that it would be so.
It is important that this assessment is based on the investor's aims and attitude towards risk: this can be fairly closely targeted by the mix that the product offers between capital preservation and the possibility of higher returns from more volatile investment vehicles.
Usually, the product has to be held to maturity if the capital protection is to operate. This is not a vehicle in which to hold money that may be needed at short notice, since exiting before the plan's maturity date could involve high charges.
A growth-based plan can yield positive returns even if direct investments in a market would have produced a loss. Income options can return more than your investment could earn on deposit. Either of these outcomes is available with a degree of capital protection.

Conversely, caps on participation rates will limit the returns investors could have made in a strongly rising market.
Death and taxes
These are subjects that revolve around the nature of the vehicle behind the structured product, and its tax domicile.
The earlier products were founded on life assurance bonds, and some of the underlying contracts were written by offices in jurisdictions like the Isle of Man, which is still a big offshore insurance centre today.
More recently, tax-efficiency has been increased through the establishment of offshore investment companies - many based in Dublin - and the use of Medium Term Notes (fixed-term bonds issued by major European banks).
Tax treatment will depend on which of these various instruments lies behind the product offering. The following guidelines are correct at the time of writing, but may change with new legislation.
UK life assurance bonds:
All growth and income gains are taxable, and basic-rate tax will be deducted at source. Higher-rate taxpayers are responsible for paying the difference between the tax already deducted and the higher rate that is due. Non-taxpayers cannot claim a refund of the tax deducted.
Offshore life assurance bonds: No tax deductions are made at source, and any proceeds from income or growth are paid to the investor gross. These must be declared on tax returns as they are received. However, this does mean that you will not have had tax deducted at source, and will not have to pay it if it is not due. Also, for investors in growth-type products, gains are only declarable when they are realised or repatriated to the UK, which provides a useful tax-deferral facility.
Life assurance bonds have one disadvantage, in that they do not qualify for ISA or PEP wrappers.
Offshore investment companies:
The structured product here consists of shares in a closed-end investment company, similar to UK Investment Trust. These are established for the purpose by well-known financial institutions in offshore centres.
Income from these plans is paid gross of tax and, as with offshore bonds, non-taxpayers will not have to pay any. Taxpayers will have to declare income, but since it is treated as an offshore dividend, it will be taxed at a lower rate than onshore payments. Any returns made under a growth option are subject to capital gains tax (CGT) rules, which means that they will be exempt up to the annual CGT personal limit, and will also qualify for taper relief if the shares have been held for three or more years.

These companies do qualify for ISA and PEP wrappers, thus adding a further layer of tax-efficiency.

Medium Term Notes (MTNs), or listed bonds:
These are fixed-term bonds issued by major European (including UK) banks. Tax treatment is not so advantageous as offshore companies, since investors must declare all income from this source, and pay tax at their highest rate. As before, returns from growth options above the annual personal limit are subject to CGT.
Upon death of the investor, life assurance-based products will pay out their proceeds to the investor's estate. Other products will transfer to the investor's estate, and be handled by the trustees according to the investor's wishes, but will lose their PEP or ISA eligibility in the process.
Timescales and costs
A structured product is an investment for a fixed term, at the maturity of which the plan is closed and investors are paid out. Typical investment periods will be five or six years, although shorter and longer terms are marketed. Plans with a 'kick-out' provision could mature earlier than their nominal term, if the investment return objectives have been met. In all cases it is important to hold the investment until maturity in order to avoid annulling any capital protection provisions, and the high costs of early withdrawal.
It is not unusual for some products to run for odd periods, like five years and three months, and the extra period allows for the final reckoning to be completed, and the plan's assets to be realised.
Costs are calculated at the outset, and taken into account in the product's projections. This means that 'what you see is what you get': the returns from the investment already have all the fees and charges deducted.
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