Structured products: not so safe after all

Structured products were meant to offer investors the best of both worlds. Designed to provide returns when markets go up, but also to protect your capital when they fall, they're not a hard product to sell, particularly at times like these. After all, even if markets crash, you'll at least get your money back, right? Sadly not, as it turns out.

Most structured products have an investment term of, say, five years. The idea is that at the end of the term you get your initial investment back, plus a proportion or a multiple of any rise in a chosen index. In some cases, your capital may be at risk if the index falls particularly sharply. But a more serious threat to your capital is only now becoming clear to some investors.

The problem is that these plans are backed by a counterparty, usually an investment bank, whose bonds provide the capital protection. If the counterparty goes bust, you'll join the queue of creditors, meaning you may suffer the loss of some or even all of your capital.

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Before the current crisis, the idea of a large financial company going under seemed unthinkable to many. But now, with the counterparties of some of these products including Lehman Brothers and insurer AIG, this has become a big issue.

While AIG has been bailed out by the US government, so the products it backs seem safe for now, in the UK, about 20 of the structured products issued by NDF (tel: 01727-734 315), Defined Returns (0845-603 2328), Arc Capital & Income (0845-890 8915) and Meteor Asset Management (0845-009 1805) were backed by Lehman's securities. Each of the above firms is now a creditor of Lehman, scrabbling for a share of whatever's left of the former investment bank once the administrator, PricewaterhouseCoopers, has gone over the remaining scraps. Sadly, the Financial Services Compensation Scheme (FSCS) cannot help, because it only offers compensation if the product issuer itself, for example Arc or Defined Returns, becomes insolvent.

If you are still interested in investing in a structured product, then be aware that issuers are not obliged to tell investors who the underwriting bank is. But if they refuse to say anything other than that it is "an issuer rated A by Standard and Poor's", as has been common practice, then you've every right to be wary Lehman had that rating before it went bust. In any case, we wouldn't recommend these "capital-protected" structured products if you really can't bear the thought of risking your capital, keep it in a decent, government-backed savings account. It's a lot safer than relying on the health of any financial institution right now.