Investment

13 November 2008


Managing Director, Worldwide Financial Planning, Writes:
With all the negative euphoria in the world today it is easy to see why there are a range of structured or guaranteed products being released.

It’s a well known fact that I cannot stand them and most people don’t even understand their risk.

So if you have seen any of the arrangements in the shop windows of banks (normal hiding place for them) prepare to be enlightened. I will use Cater Allen’s recent offering as an example. Cater Allen is part of the Abbey group.

I describe these ‘capital protected’ or ‘guaranteed plans’ as a bit like wetting a piece of cotton and pushing it into the air. A Fruitless task with no real benefit at the end, but it passes the time when nothing else is happening.

Cater Allen’s selected UK banking plan2 offers 11% return in any of the first four years if the value of each of four banking stocks is higher than the initial price they are bought at. Year two would be 22% and so on. (1)

This might seem a great idea at first. As an investment adviser I think it’s brutal. The plan is sold on the basis that banking shares have taken a hiding and are cheap.

That statement was also mentioned five months ago. You now know anything that can get cheap can get much cheaper. These options of maturing in each year only if all four stocks are higher than their initial strike price represent poor value.

If the four stocks do rise and they soar, you will get a maximum of 11% in the first year. If they all fly except one, you won’t get a penny. All four have to rise.

This is an inverse of modern portfolio theory. Consider that the four stocks are Lloyds, Barclays, RBS and HBOS and you may now have taken your eye off a headline rate of 11%. In a normal spread of the four stocks you would get a spread of their performance.

In this instance 100% per year for three stocks and zero or less on another would mean that you wouldn’t get a penny on each year until the plan matures.

Any plan that offers an ‘early maturity’ option, basically a short term kick-out option’ should be avoided at all costs.

At maturity, the plan will give you an average of the value of each of the four banking stocks but this average is over the last two years, which will clearly dilute the upside of the returns. Averaging should be just the last year at most.

Consider that you will be giving up a large proportion of your returns as they do not pay dividends in this type of arrangement.

Lloyds has been averaging c35p per share dividend over the last seven years. (2) Within a structured plan these are lost. Is it really worth that risk?

Speaking of which, what’s the guarantee really worth.

The guarantee is provided by a counterparty. In this instance that is Abbey national treasury services (ANTS).

How many customers know what that really means to them? Do they know what risk ANTS carry?

What is the real potential for loss here? Do they know that if ANTS goes bust the customer will get nothing? You see it’s down to the FSCS rules which state the customer is not the investor and Cater Allen as the investor, is caught under the large company rule so FSCS doesn’t come into play and you have no protection at all.

The documents explain that it is 'unlikely' that ANTS will fail to repay the loan at the end of the term. Mmmm. Why is it unlikely? We are never caught by likely events.

We therefore have to think and look very closely, not just at the fine print, but what that fine print actually means and how it can affect you.

There is an abundance of these arrangements around and they will continue to be offered as a simple protected investment to the upsides of the stock market. As you can see they are not.

If you have a financial query call Peter on 0800 0112825 or e-mail info@wwfp.net

Sources:

(1) http://www.caterallenstructuredproducts.co.uk/Default.aspx?pid=1
(2)http://www.mediacentre.lloydstsb.com/ir/uk_dividend_history_page.asp

Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
The above represents the personal opinions of Peter McGahan.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.