QROPS MYTH #7 – Structured notes are suitable investments

There have been many cases of clients losing significant proportions of their pension due to unsuitable investments that were sold with the only aim of making commission for the advisor.

Structured notes are sophisticated investment products that are too complex to be understood by the average retail client who is simply looking for a balanced portfolio that will grow steadily over the long term with minimal bumps in the road along the way.

Clients are often blinded by the promise of a fixed return based on their performance of underlying indexes. They are presented in such a way that makes them sound too good to fail and in a way that sounds appealing. It is too easy to be fooled by a promise of a ‘guaranteed’ return and it can sound more lucrative than the uncertainty of regular investments which can fluctuate.

As an example, an advisor might suggest to a client that they invest £100,000 in a structured note that will give them a return of 8% per annum as long three indexes are above a certain level. There’s a defined upside but no defined downside. The worst case scenario is that if one of those indexes drops below that level on the observation date then the capital is at risk.

Even if the structured note fulfils its promise it is important to consider how much it cost in the first place. We’ve seen structured notes that involve a 4% up front fee (a ‘distribution fee’ paid to the advisor). To put that in context, the advisor has a conversation with a client about investing £100,000 in a structured note that might pay out a return of 8% in a years’ time. The advisor makes £4,000 on day one and experiences no risk. The client is now left with £96,000 invested into the note and must wait a year to see if they can receive an 8% return. A year down the line and the advisor contacts the client to excitedly inform him that the note has paid out a return of 8% and the original capital will be returned. Great success! Or maybe not. 8% of £96,000 is £7,680. From the original £100,000 that the client now has £96,000 + £7,680 = £103,680.

In summary, the client invested £100,000. The advisor pocketed £4,000 on day one and the client made a profit of £3,680 on day 365. Does that sound fair to you?

Aside from structured notes, these offshore advisors also favour utilising actively managed funds with high total expense ratios.

One of the favoured managers is GAM which made headlines last year for its internal problems.

https://www.ft.com/content/56e5b0ba-39ed-11e9-b856-5404d3811663

Clients invested into GAM should be aware of the following data taken from the Morningstar website:

GAM Star Fund plc – GAM Star Balanced Class C GBP Accumulation

The initial charge of 5% is paid to the advisor with an additional ongoing charge of 3.08%

Let’s put that in context with the example of £100,000 invested on the 1^st January, 2016:

In summary, the costs on GAM are the difference between the first column and the last: £91,276 or £103,427. 

High costs on funds are easier to disguise when markets are rising but when markets drop then it can be like trying to swim with heavy weights tied to your legs – you can try your best but ultimately you are doomed to sink faster than a lighter object.