Advice is Key

January 27, 2016

Back in 2008/09, the market for structured products was under intense scrutiny by regulators after the collapse of Lehman Brothers left some investors high and dry. A subsequent FCA review of the suitability of advice on structured products found several main failings, importantly: a failure to consider the suitability of the products from a risk perspective, and an over-concentration of clients’ assets into structured products. 

Now, it is easy to say that these failings are unique to structured products; but they are not! Instead, the culture of brokering product without a coherent investment philosophy and process applies to how many other investment products are sold also. So much so that the US has recently passed a ‘fiduciary responsibility’ law governing financial advice given to retail investors. 

Advisors need to work with their clients to define investors’ need for access to their money in an emergency, for  example. Easily liquidated assets available for sale on a secondary market should be used if investors demand liquidity in a structured product. The level of capital guarantee and most importantly, how that guarantee is provided also needs to be openly discussed. The key to correct due diligence and market research for structured products is no different from any other investment solution; it is about asking the right broad-based ‘enhanced suitability’ questions.

It is crucial to be able to assess both risk and capacity for loss and apply this to the selection of the correct structured product. There must be a logical link between the investment selected for the client and the agreed risk profile and documented capacity for loss. It should be noted that many firms are still getting this wrong, as the FCA review of suitability in wealth management firms has found. When assessing structured products against the risk profile and capacity for loss, there are many considerations. Once simple mnemonic firms apply is CLEAR:

Counterparty – who is making what promises and how likely they are to keep them?

Length – is the term appropriate for the client’s planning needs and tax circumstances?

Exposure – what is the client actually exposed to and does this meet their capacity for loss?

Access – where can the product be held (inside an tax-efficient insurance policy or through brokerage account) and is this appropriate?

Risk – does it match the investor’s profile?

These screening criteria are most difficult to apply to very complex structured products. Therefore, simplicity is key. Look for easily accessible underlyings, like major indexes and ETFs.  Look for simple structures such as auto calls (with low barriers), capital guaranteed products, and credit linked notes. One simple rule of thumb can be used for all advice, if it is too complicated to explain to a friend in 30 seconds, don’t use it.

Of course, a strong advice process needs to be backed by competent advisers well educated in structured products. AdvancEquities is happy to work with advisors demonstrating that they understand the above process, thereby protecting both advisers and their clients from unsuitable advice.