What are Structured Notes – Why offshore financial advisers love them

A Structured Note is a common term used for a Structured Investments which is a type of Structured product, going by UK investment definitions.

Many people who have already transferred their UK pensions using an offshore financial adviser will probably have already been introduced to structured notes at some point. They are a favourite of offshore advisers, mainly due to the fact that they receive a hidden commission of 4% of the investment when you invest in one.

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How do Structured Notes work

However, structured notes are complex investments and most people don’t really understand how they work and therefore don’t fully understand the risks involved. The worrying thing is that most offshore financial advisers don’t understand how they work either.

Structured notes generally provide you with a fixed return or bonus on maturity of a specified period. The return or bonus you receive on maturity is normally based on a particular share index, such as the FTSE 100, or can be a basket of four or five individual shares.

Here’s an example:

• If the FTSE 100 is higher at the end of the five years than it was at the beginning, you get your original investment back plus an extra 30% – a total of £1,300.
• If the FTSE 100 is at the same level or lower than it was at the beginning, but is less than 50% lower, you get your original investment of £1,000 back but nothing extra.
• If the FTSE 100 has fallen by 50% or more, the amount of your original investment you get back is cut by the same percentage – so if the FTSE 100 has fallen by 60%, you’d only get 40% of your money back, a total of £400. 

Your initial investment is normally used to pay fees to the provider and commission to the adviser, a derivative or option to provide the return, and a zero coupon bond to give your money back at maturity.

Most Structured notes will be promoted by a large bank or investment manager, however, it’s not usually that firm which promises to return your original investment or to pay a given return on your money.

Instead they will buy some complex underlying investments from one or more other companies, often referred to as ‘counterparties’.

What does ‘Capital Protected’ mean

Some structured products often talk about ‘capital protection’ – but this doesn’t necessarily mean that your money is completely safe. There are two common types of protection:

• Full protection – also described as ‘100% capital protection’, ‘capital security’ or a ‘capital guarantee’, this means that the minimum that you receive on maturity should be at least equal to the amount originally invested.
• Partial protection – how much of your original money you get back depends on the performance of the index your product is based on and only a proportion – say 90% – is protected by the capital ‘guarantee’.

In either case, there is still potential for capital loss as described above, if the counterparty providing the guarantee runs into trouble.

Because you don’t have any agreement yourself with the counter parties, if any of them fails (you don’t get your money back or the promised return) you don’t have any direct claim on the counterparty and no compensation scheme would apply.

Instead, you would have to try to seek redress from the financial adviser that sold you the product. There are a lot of unregulated advisers selling these products, as well as regulated advisers, however, in the offshore world regulation doesn’t count for much. It can be very difficult to get enforcement action on an offshore financial adviser.

An unfortunate case in recent times is that of clients of Continental Wealth Management in Spain. Expats had transferred their pensions on the advice of financial advisers from this firm and their pensions were heavily invested into Structured notes.

The structured note collapsed and clients lost huge amounts, some up to 90% of their pension with an estimated total loss of €20million from 400 investors. Not surprisingly the Directors of CWM are now nowhere to be seen and hundreds of investors have had their pensions decimated. Unfortunately, this scenario is not uncommon when dealing with an offshore adviser.

Should I invest in a Structured Note

Structured investments lack liquidity and cannot be sold easily. This means if you need access to the money in your pension, you will have to wait until the product matures or try and sell and hope you get a good price for it.

Most structured notes that are sold to pension investors who are outside of the UK, are only meant to be sold to professional investors or institutions such as banks, investment funds or experienced investors working in the investment industry.

If you get to see the small print of one of these structured notes and it says on there it is for professional investors only, this is for good reason. This is to warn investors that the product is complex and difficult to understand, there are large risks involved and there is no protection for investors if things go wrong.

Structured notes rely heavily on ‘Derivatives’ and ‘Stock Options’. Heard of these before? They were heavily involved in the global financial crash of 2008.

If you’re sold a structured investment product in the UK, the providers must give you ‘key facts’ information that you can understand, covering:

• What the investment is and how it works.
• The key risks including the risk of capital loss and counterparty risks.
• Charges (the fees that will be deducted from your returns or capital).
• When you’ll have the right to access to the Financial Ombudsman service and the Financial Services Compensation Scheme.

If you are interested in buying a structured note from an adviser outside of the UK, you should still request this information as it will help you understand the risks for the product and enable you to make an informed decision on the investment.

Only invest if you completely understand how it works, the risks involved and the potential impact if things go wrong. Here’s what the Financial Conduct Authority (FCA) in the UK think about structured products.