Don’t Tar All Index Products With The Same Brush

Index trackers, ETFs, structured products and deposits are very different beasts

Editor, Europe
Reviewed by: Rachael Revesz
Edited by: Rachael Revesz

As the UK regulator fines structured product manufacturers and distributors for misleading marketing material based on an index product, it would be tempting to lump all index tracking vehicles under the same banner.

The Financial Conduct Authority (FCA) announced today that it has fined Credit Suisse and Yorkshire Building Society a combined £1,429,000  (€1,792,000) for mis-selling a structured deposit, which aims to provide capital protection and guarantees a minimum return, along with a potential bonus if the FTSE 100 index performs consistently well.

However, the chance of only receiving the basic return was up to 50 percent, and there was close to no chance of receiving the maximum return, the FCA found. Despite this, the maximum return was strongly advertised and targeted at conservative and risk averse clients.

A total of 83,777 customers invested three-thirds of a billion pounds in the product. It seems that the days of the shiny salesman on your doorstep in a pinstriped suit is outdated, but the shiny brochure with striking images of battleships crossing stormy seas is still rather effective.

While structured deposits share similarities with other index products like exchange traded funds, such as depending on the underlying index and being rules-based, they are still very different. ETFs are listed, can be traded intraday, tend to be cheaper than a structured plan and have no caps or limits attached.

But investors could be forgiven for tarring all index products with the same brush. For example, Investec Structured Products, one of the main providers of structured plans to UK advisors, recently launched two passive, index tracking funds. They are not structured products, but you couldn’t be blamed for first assuming otherwise. Both funds rely on the performance of the underlying index, come from the same provider, and are heavily marketed.

The accused “Cliquet Product” from Credit Suisse and Yorkshire Building Society is a typical example of a hybrid between a structured product and a structured deposit. It is a capital protected plan that lasts four to six years and guarantees a minimum return over that period. Returns also depend on the performance of the underlying index, which is normally the FTSE 100. In this case, if the sum of the FTSE 100 returns exceed the minimum guaranteed return over six months, the deposit will pay out the index returns.

However, as the FCA highlighted, there was virtually no chance of that happening. Secondly, the product did not track the FTSE 100 exactly – there was a floor and a cap by how far the index could go, which looks comforting in a bear market but might brew resentment in a bull run.

Take another look: for the FTSE 100 returns to be paid out, the index had to rise by a certain point (the level of the cap) in every six month period until the fund expired.

The financial promotions and brochures did not clearly explain how returns are calculated.

Tracey McDermott, FCA’s director of enforcement and financial crime, said: “It is crucial that firms consider the needs of their customers from the time that products are being designed through to their marketing and sale. The information provided to customers forms an important part of this.”

With all this in mind, consider just a few names that the Cliquet Product was sold under: Protected Capital Plus Account; Guaranteed Capital Account; Protected Capital Account; and Guaranteed Investment Account.

This naming issue rings bells in the passive world too – the smart beta label, for example, implies that competing strategies are dumb.

A statement from the FCA read: “The FCA is interested in how behavioural economics can help understand why consumers make the decisions they do.  Some of the issues raised in this case will be examined as part of its ongoing work.”

It will be interesting to see the results of this FCA work. Are customers motivated by the naming of products; they see the word “guaranteed” and believe it? Are customers heavily influenced by marketing salespeople and shiny brochures instead of making their own informed choices?

Certainly, structured deposits and products have faced their own criticisms from financial advisors for being risky, non-transparent and having counterparty risk. Yet many investors are willing to get involved.

But that’s not to say that all index-tracking funds are good or bad, or that you can’t find a decent income-yielding structured deposit, or a genuine, low priced FTSE 100 ETF.

Just don’t rely on the shiny brochure and make up your own mind.

Rachael Revesz joined in August 2013 as staff writer. Previously an investment reporter at Citywire, she has a background in writing content for retail financial advisors and has covered a wide range of subjects in finance. Revesz studied journalism at PMA Media, which has since merged with the Press Association. She also holds a B.A. in modern languages from Durham University, as well as CF1 and CF2 financial planning certificates from the CII.