Why? “Structured” should raise eyebrows, because “structuring” is typically used to render investment vehicles more opaque and therefore more expensive for the end-user.
“Guaranteed” is also usually bad news, because a guaranteed (or “principal-protected”) investment vehicle is usually full of embedded options, and the main game of Wall Street for the last decade or two has been the packaging-up of lots of options and selling them at vastly inflated prices to the unsuspecting retail investor.
Just how lucrative the whole retail structured products business has been to financial intermediaries was revealed in a story in the Financial Times a couple of days ago, which in turn quoted a research report from the Swiss bank UBS.
Man Group charges investors 8.5% a year, plus performance fees, to invest in one of its flagship funds, a guaranteed hedge fund. Here investors are paying multiple layers of fees, for the hedge funds themselves, for the capital guarantee, and for leverage.
It hasn’t stopped people investing – Man had, on average, $44 billion under management from wealthy individuals in the six months to the end of September. Man has reportedly produced an average annual return of nearly 8% in its flagship IP 220 fund in the five years to end-September, after fees, so it’s not all bad news. Nevertheless, one wonders if these investors knew quite how costly an investment product they were buying.
Unfortunately the structured/guaranteed (opaque, expensive) versus indexed/ETF (transparent/good) dichotomy that I set out earlier is a false one. It’s not as simple as that. Strictly speaking ETFs themselves could be labelled structured products, particularly those using swap-based replication and/or leverage. And there may be embedded options in some tracker products, for example the early redemption facility in ETNs.
So, as always, the devil is in the detail. Here’s one checklist that any advisor or investor could go through when evaluating any new fund, whether a complex guaranteed structure or a tracker fund, and which should throw some light on whether it’s good value or not.
- Costs – how much does the product provider and/or intermediary charge? This may be very difficult to establish for some structured products. If you can’t answer this, don’t buy the fund. There may be hidden costs in some trackers as well – how much index turnover is there likely to be, and what will be the rebalancing costs?
- Are upside returns capped? This is typical for many structured products.
- Does the investor give up yield? Again, structured/guaranteed products may guarantee the index (capital) return, but at the cost of forgoing dividend income. This can have a huge effect over a multi-year period.
- Are there embedded options? If the fund is guaranteed, there will be. If there are hedge funds involved, there will be, as hedge fund fees are effectively an option given to the fund manager by the investor. Structures using options can be very expensive.
- Leverage – does the fund use leverage, how does it work, how is it charged for, and are there likely to be tracking problems?
- Liquidity – can investors trade into and out of their products or are they locked in until maturity (for a fixed-term product)?
- Counterparty exposures – is there full counterparty exposure to the issuer, or is there collateral coverage?