using structured products for income

Used constructively, structured products can generate useful income streams for client portfolios, says Ian Lowes, founder of

using structured products for income

However, structured products offer alternatives to traditional income generating investments that for clients looking for above cash returns can be useful additions to their portfolio.

It has to be said that structured products have not been immune to the dramatic fall in interest rates (swap rates within the banks) post the Financial Crisis, which have been additionally impacted by the Government’s recent Funding for Lending Scheme that has reduced the banks’ appetite for funds. As with much of the market this has limited the ability of a structured product to produce income.

Pre-financial crisis a ‘typical’ income structured product might have offered terms, backed by a major bank (counterparty) and subject to the bank’s continued solvency, which offered an annual income of say 7% for five years with all capital returned at maturity provided the FTSE 100 index did not fall by more than say 40% or 50% during the term.

Market innovation

In the current market this kind of product is just not possible to structure. But this has led to innovation within the market and the introduction of structured investments with contingent income. So, this type of contract might be able to offer a similar level of income and similar capital at risk parameters as the pre-crisis product described above but in order to offer the same high rate the income would not be paid in a year that the FTSE closed on any day below, say, 4,000 points or above 8,000 points. The acceptance of the additional risk that the income might not be paid generates the higher income potential.

In this example the failure of the investment to pay income in a year that the FTSE was above 8000 points might not be an issue if the client has other investments from which they could take gains but in years when the FTSE is significantly depressed it could be problematic.

Hence, the use of such contracts needs to be considered very carefully, balancing the client’s overall attitude to risk and willingness to trade potentially higher reward for the greater risk of not achieving income needs in some years. But any such investment would not be used as the sole income solution for the client.

Better blending

In fact, an alternative or complementary strategy, particularly where other income investments are being used, is to seek out regular payments utilising growth investments that take advantage of the client’s CGT allowances. For example, structuring a mini portfolio of these investments that are then used to provide a regular or ad-hoc payment can be a much more tax efficient approach.

The ‘income’ tax saving could result in either a higher income being achieved or the need to take less risk. While there are many structured products that would work very well within such a strategy, autocall contracts that can mature with a coupon of say 8% for each year held, payable on the first anniversary that the index is higher, are one such example.

Through blending structured income products with growth investments it is possible to deliver a viable income stream by spreading the investment potential and the risk for the investor, all delivered as part of a broadly diversified total investment strategy.

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