Lehman's legacy sparks spat over 'unsafe' package

They were cited as the cause of 6,000 UK investors losing their life savings; the focus of a major regulator investigation that resulted in large fines for providers and advisers; and now the UK's leading consumer group has warned investors to steer well clear of them.

In the double-speak jargon of financial services they're called structured products. In essence, these structured products are designed to offer total or partial capital guarantee while enjoying some growth or regular income from the performance of an underlying investment. They are supposed to be the financial services equivalent of the philosopher's stone, but, critics say, they are expensive, complex, and not as safe as presented.

The financial services industry, though, is fighting back, dismissing Which?'s claims that structured products are "too complex and costly" as "far too crude" and "unfair" on a product that is used effectively by investors.

Which? named structured products in a list of 10 financial products to avoid, and said that consumers would be better served by an individual savings account (ISA). But Julie Smith, head of structured product research at the online financial services providers Fair Investment Company, says that to suggest ISAs as an alternative to structured products makes "no sense". "ISAs are a tax-efficient wrapper, and there are many different types of investment products that can be held in an ISA, including structured products," she says. "You cannot suggest a tax-efficient wrapper as an alternative to an investment product. It is not comparing like for like."

But the consumer watchdog stands by its claims. "These are complicated products that are not suitable for the vast majority of investors," says a Which? spokesman. "While we acknowledge that there are some transparent providers and that progress has been made to make these products clearer, we still have very serious concerns about the level of explanation of the real risks involved, and what the guarantees actually mean.

"Our particular concern is the banks, which create these products, selling them in high street branches to people who just walk in off the street. Their advisers are incentivised to sell products that make their organisations far more money, rather than encourage customers to open a savings account, which in most cases would be much more suitable."

Which?'s concerns were sparked by the plight of about 6,000 UK investors who lost their life savings following the collapse of Lehman Brothers in 2008. The investors were left holding worthless structured products that were backed by the US bank. Despite the "guarantees" that at the very least their stake money would be returned, these investors received nothing when the bank went under.

In the wake of Lehman's collapse, the Financial Services Authority investigated the marketing and distribution of structured products. As a result, the FSA fined RSM Tenon Financial Services Limited £700,000 for, among other things, having "poor systems and controls to prevent unsuitable advice in its structured product business".

Despite their troubled past, structured products still have many champions who believe that they offer a useful addition to a well-rounded investment portfolio. A survey last month showed about 90 per cent of 130 independent financial advisers use structured products as a way of offering their clients capital protection.

The Structured Products Association, the professional body for the industry, believes the Which? report is "out of date" and "ill-informed". "When Lehman collapsed, most investors were affected," says an SPA spokesman. "But of the top 20 complaints to the Financial Ombudsman Service, structured products are not even on the list. About £13.9bn was invested in structured products in 2009, a sector which accounted for just 1 per cent of complaints to the FOS."

David Willcox, investment director of City Asset Management, is a firm proponent of structured products, describing them as "a valuable tool to reduce risk in a portfolio, to protect against falls in stock markets such as the FTSE".

But Mr Willcox agrees that they are very complex. "Investors, and their advisers, need to understand the complicated pattern that is made up of fees, bonds and options. There are common and unique features to every SP and you really need a working knowledge to compare each aspect to ensure value for money."

Likewise, Colin Jackson, director of Baronworth Investment Services, advocates the use of structured products. "It is disappointing when people put so much reliance on Which?, and that it does not recognise these are good products in certain circumstances," he says. "As long as both provider and client fully understand the product, they can be a valuable addition to a portfolio. There are lots of people who need a high level of income from their investments and these products can provide that, so long as the risks are properly understood."

But Jason Witcombe, a chartered financial planner and director of the independent financial adviser Evolve, cannot see any reason why anyone would choose a structured product. "We do not ever recommend structured products to our clients and never have. They are hugely expensive and the charging structure is very opaque," he says. "Clients really do not need to buy insurance, which was what they are effectively doing, to protect their money from long-term ups and downs of the markets."

He suggests that the reason they are still on the market is that the banks and their advisers benefit. "Structured products are first and foremost a way to make money for the big institutions," he says. "Advisers get paid hefty commissions and know that when the product matures in five years, they are well placed to 'sell' their client another. The whole marketing ploy is to try to convince that risk and rewards do not go hand in hand and that's simply not true."

As with all investment products, it is up to investors to choose the most suitable package. As Which?'s spokesman says: "We are not calling for structured products to be outlawed or banned. We just want them to become far more transparent and sold only to those they're really suitable for, who fully understand all the risks."

Structured products explained

Typically, they have two underlying investment components:

1. A note or bond that provides the capital protection and is provided by a bank, or another institution or government;

2. A derivative or option (ie a financial instrument linked to the value of something else, such as a stock market index or the price of another asset, such as oil or gold). This component is used to provide the potential growth element that you could get at maturity. Investors are usually offered only a share of any increase in the level of the index or asset price that occurs during the term of the investment.

There are two main types of SPs

1. Growth plan: "guarantees" your original investment back after five years if the FTSE, or another asset, does not fall below the level it was when the plan started. If it is higher, you get an additional return.

2. Annual income plan: gives a fixed percentage of the invested money a year, until the end of the plan, when your original investment is returned untouched. Unless the underlying asset that is being tracked has fallen on the last day of the term by more than 50 per cent, then a certain fixed percentage is taken from the capital.

Expert View

Jason Witcombe, Evolve

"The key issue with structured products is that they contain hidden risks that are hard to quantify or explain, even by an expert. There are so many things factored into them. It's also really difficult to compare like with like, to assess the real value of each product, as each is significantly different from another. They are far too readily sold to people, who don't need anything so complicated. A plain vanilla investment serves the vast majority well."