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Cherry Reynard looks at how structured products can add an extra dimension to drawdown portfolios.
Structured products have had something of a complex history. There were undoubtedly a few bad apples, which departed the market some years ago, but a more integral problem for many investors was the difficulty of comparing them with conventional open-ended funds and fitting them into a wider portfolio.
However, new changes in legislation may solve this problem, allowing structured products to be assessed more objectively.
Under the Packaged Retail and Insurance-based Investment Products rules, the key investor information documents will have to show a prescribed set of information.
This includes a 1-7 risk scale, cost information and an indication of likely future performance. There may also be some form of scenario planning, showing how performance may change in differing market scenarios, although this has proved a controversial area and has contributed to delays in implementation.
New opportunities
Whatever happens on that point, advisers who once dismissed structured products as either too complex or too difficult to analyse will now have independent tools at their immediate disposal.
Colin Brockman, head of retail distribution for Investec structured equity derivatives, explained: “Advisers who have felt a bit uncomfortable or in-the-dark about how to assess the credit risk of a counterparty, for example, will be able to look at these new documents and clearly see the market and credit risk.
“In this way, they will be able to compare apples with apples in a way they haven’t been able to before.”
The ability to make more ready comparisons with collective investments – both in terms of risk and potential reward – can only be helpful at a time when the need for alternative investment solutions in retirement has never been greater.
The government has tinkered not only with the pension system, but also with elements of the tax system (for example, capital gains tax and dividend tax). This has served to only increase complexity for retirees and their advisers, encouraging many to look for a diversity of income sources in retirement.
Those retirees relying solely on buy-to-let income, for example, have seen their tax allowances cut, while at the same time, capital gains tax on investments has fallen. Everyone now has a dividend allowance and a personal savings allowances.
In order to use these to the full, retirees need to draw income from share dividends, interest on savings and gains on capital sales as well as the usual pension and ISA income.
Clearly, however, such an option will not be open to everyone. Those with relatively small pension pots are still likely to be confined to buying an annuity. But those with larger pots, who are in the position of contemplating a drawdown portfolio, need to consider all their options in more detail.
Achieving growth
At the heart of the dilemma for investors is how to balance stability and the need for a regular and reasonably reliable income, with retaining control over a portfolio, generating inflation-linked growth, and (potentially) leaving something behind at the end of the day.
Annuities may pass the first test, but tend to fall short on the latter. For drawdown portfolios, the converse is true.
Structured products are one of a number of what Brockman described as potential ‘third way’ solutions.
“More traditional third way options offer some kind of ‘guaranteed drawdown’, whereby investors take a secure income but retain access to the capital.
“The income may be lower than that available on a conventional annuity, but it can be a welcome middle ground for investors. The cost of the guarantee can, however, be high.”
Used in the right way, Brockman argued, structured products are capable of providing a similar investment trajectory and for better value.
Investec has previously launched retirement targeted structured products. While not operating as full drawdown, they are more flexible than a standard annuity and are designed to add some level
of predictability to income or growth.
With both income and growth options. Among the former is the FTSE 100 Retirement Deposit Plan 10. It pays fixed annual payments of 3.75% over the six-year term with the remainder paid at maturity.
An additional 22.5% is paid out if the FTSE 100 is higher than 90% of its initial level. If the ‘final index level’ (calculated as the average of the closing levels of the FTSE 100 on each business day for the final six months of the plan) is equal to or lower than 90% of the initial index level, investors would receive the remaining 77.5% of their initial deposit but no additional return.
“The plan provides a means to participate in some of the return from the FTSE 100 while not taking risk with the capital,” said Brockman.
The product can be held within a cash ISA, offshore bond, a SIPP or an SSAS.
Structured results
For its part, the FTSE 100 Defensive Growth Plan offers a similar structure. But as the name suggests, it has more of a growth slant. It is designed for investors who are nervous on stockmarket growth, but are nevertheless willing to put their capital at risk with a view (potentially) to achieving a higher return.
The plan repays the initial investment with a return of 34% after six years, providing the FTSE 100 is higher than, or equal to, 50% of its initial level. If the final index level is lower than 50% of the initial index level, the protection disappears and a client’s investment falls by 1% for every 1% fall in the index at the end of the term.
These products were the first that Investec had specifically created for the post-retirement market – although, in practice, other types of structured products may have a role to play in allowing investors to build a more predictable and balanced portfolio in retirement.
“Advisers with clients who are in a position to think about drawdown should be looking hard at the role structured products can play,” said Brockman.
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