Many UK retail investors overestimate the expected returns on structured deposits and do not recognise that the structured products are unlikely to offer greater returns compared with best-buy fixed-term cash deposits, according to a behavioural economics research paper published today by the Financial Conduct Authority (FCA).
“We find the FCA conclusions difficult in so far as they do not allow for any judgment whether retail investors would have also undergone the assumed ‘yield overestimations’ with financial products other than structured deposits (especially those that too have a non-fixed return),” said Thomas Wulf, secretary general at European Structured Investment Products Association (Eusipa).
Respondents were asked to anticipate how the FTSE 100 would increase over time and then for their expectations for structured deposits linked to the benchmark index over the same period, said the FCA in a statement. While consumer expectations for FTSE growth were in line with the FCA’s assumptions, they did not match the returns they anticipated on structured products based on the same benchmark, stated the UK regulator. The FCA found that, on average, returns were overestimated by almost 10% of the assumed investment amount over five years.
“Most, if not all structured products are manufactured to deliver a return based on a certain market scenario,” said Wulf, adding that ultimately any investor will hence need to have an opinion about the market he is investing in. “Here it is of course always easy to pick out with hindsight products whose underlying market expectation did at maturity not (fully) materialise. The risk that this may happen finally is the difference, which signifies an opportunity and risk at the same time, between a ‘risk-free’ deposit (a term which is correct only if you leave aside inflation and issuer risk) and a risk-bearing investment product. To compare risk-free and risk-bearing products however, is comparing apples and pears.”
More interesting for investors would be to compare financial (risk-bearing) products that an investor can gain more from, or at least the same as from a direct investment in a stock or an index, said Wulf. “We would favour an analysis of comparing investments in the same underlying risk through a note-based structured products, a Ucits fund and a direct share/bond investment,” he said.
The research also revealed that consumers did not recognise that structured products designed for the purpose of the research were unlikely to offer greater returns compared with best-buy fixed-term cash deposits. Consumers needed to be offered relatively high rates of return on risk-free cash deposits for these products to be preferred to structured deposits, said the regulator. However, targeted disclosure improved how consumers make these comparisons, stated the release.
While suggesting that there is a place for structured deposits, the research shows that many consumers find it difficult to understand how they work and how to compare them to alternatives, said Tracey, director of supervision and authorisations at the FCA. McDermott said it is crucial that firms ensure the way they design and market these products is driven by consumer needs, but noted that this report suggests this is not always the case.
The research findings reinforce the importance of companies designing structured products that are a reasonable match for the financial sophistication of customers, according to the watchdog.
The FCA considered this as part of its assessment of how a sample of companies designed and manufactured structured products, which is also published today, and highlights a number of areas of concern where some companies were falling short of expected standards.
In particular, senior management must do more to put customers at the forefront of their approach to product governance (target market, product development and distribution strategy); and structured products should have a reasonable prospect of delivering economic value through robust stress testing as part of their product approval process, said the FCA.
The FCA also urges firms to provide customers with “clear and balanced information” on each product and any risks; while manufacturers should strengthen the lifecycle monitoring of their products and ensuring that distributors have enough information about the manufacturer’s product.
The regulator has asked some of the companies involved in the review to undertake more work to see whether any of the issues identified may have resulted in consumers being disadvantaged.
Click in the link to read the FCA thematic review of products development and governance.
Click in the link to access the FCA survey.
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