There continues to be much misunderstanding about structured products

As they can form a valuable part of a well-diversified portfolio of savings and investments, I think it is worth spending some time understanding exactly how they work and the different risks associated with different products.

Basically there are two main types of structured products, Structuered Deposits and Structured Investments.

Structured deposits, as the name suggests, are bank deposits, and rather than pay a fixed or variable rate of interest, the deposit will pay a return based on the performance of a reference asset, often a major global equity index like FTSE 100.

They can also use single or multiple baskets of stocks.

Structured deposits are protected by the Financial Services Compensation Scheme (FSCS) up to a maximum of £85,000 like other bank deposits.

At the end of the fixed term the original deposit is to be returned to you, whether or not the trigger to pay the extra return has been met.

By way of an example, Investec Bank have available until May the “FTSE 100 5 Year Deposit Plus Plan 2”. The plan will return the original deposit plus 27.5 per cent if the FTSE 100 is higher after five years, or 100 per cent of any growth in the FTSE 100 index if it rises more than 27.5 per cent during the five year term.

If the FTSE 100 finishes lower than its starting level then you will only get a return of capital (100 per cent). So, even if the FTSE 100 index has risen by only one per cent over five years, the investor will receive the original deposit plus a return of 27.5 per cent, equivalent to five per cent per annum compound.

If the index rises by over 27.5 per cent the investor gets all the additional return as well. The quoted returns are gross and liable to income tax if a taxpayer, or can be tax free if held in an ISA.

Structured investments not deposit plans and are not covered by the Financial Services Compensation Scheme, They are often called “Structured Capital At Risk Plans” (SCARPS).

With this type of product, the original capital is at risk and indeed it is possible for an investor to lose all their then money they have invested.

Again, it is best explained by using an example of a scheme currently available, again from Investec Bank, “The FTSE 100 Enhanced Income Plan 10”.

This provides a guaranteed fixed monthly income payment of 0.46 per cent (5.52 per cent per annum) for a six year return. However, the initial investment is at risk at maturity if the FTSE 100 index falls by more than 50 per cent at any time during the six year plan.

There are structured products called “kick out” plans that can mature on any of the anniversaries of the plan if a trigger is activated. So this may for example be a five year plan but it matures after only one year if the performance criteria are met.

Structured deposits may be suitable for cautious investors seeking a return in excess of current deposit rates but with security of capital.

Structured investments are for equity style investors prepared to take more risk but may, for example, require a set level of income for a fixed term.

Anyone considering structured products really needs a clear understanding of how they works and the associated risks.

* Trevor Law is a director with Merito Financial Services, chartered financial planners, based in Solihull. E-mail: tilaw@meritofs.com