Structured deposits: an alternative home for your savings

Structured deposits: an alternative home for your savings

01 October 2013 / by Oliver Roylance-Smith

The prospect of record low savings rates continuing is forcing many savers to review how they allocate their capital in an attempt to achieve the level of returns they have previously enjoyed. Investing in the stock market inevitably involves putting your capital at risk and so is a sizeable shift away from traditional savings plans. However there is a middle ground which continues to attract increasing interest – the structured deposit. With this in mind, we take a deeper look at this savings alternative to help understand why more and more savers are starting to see their appeal.

Savings rates – nowhere to hide

Bank of England base rate continuing at 0.5%, record low savings rates, maturing fixed rate bondholders facing significant falls in yields, limited prospect of savings rates going up in the near future, above target inflation, the list goes on and worryingly the picture is an all too familiar one.

Longer term fixed rates where historically the higher rates could be achieved are failing to meet the needs of many savers and peace of mind along with a competitive deal seems to have vanished completely. With the prevailing wind of economic consensus that interest rates will remain low for some time to come, this bleak outlook requires urgent attention. The bottom line is that everyone is affected and savers in particular have nowhere to hide.

Fixed rates under pressure

So long gone are the days where committing your money for longer was all you needed to secure a higher rate that also had the potential to outstrip inflation. Even with the headline rate of inflation, the Consumer Price Index (CPI), falling back from 2.8% to 2.7% in August, inflation is still a major concern for savers. At this level, all but non-taxpayers require an annual rate of 3.4% just to stand still. With leading five year fixed rates only offering around 3%, even committing your capital for longer is failing to provide a hedge against inflation.

Even worse for pensioners

Another important point to note is that over the same period, UK’s older measure of inflation and previous Bank of England target the Retail Prices Index (RPI), stood at 3.3%. Whilst the Office for National Statistics does its best to hide this it is important to realise that this was a rise of 0.2% on July’s 3.1%. Many pensioners will rue this difference because back in 2011 indexation of state, public-sector and some private-sector pensions were switched from the likely to be higher RPI to the likely to be lower CPI.

Risk warning for savers

Perhaps the warning that should be made by every provider before a customer buys a fixed rate bond is to make it quite clear that they will lose money in real terms unless inflation falls sharply and remains lower than its current level. If you have not yet done so perhaps you need to ask yourself the likelihood of this happening? The impact of inflation, especially over time, is something which not enough savers put sufficiently high on their priority list prior to taking action.

So savers are faced with the toughest of decisions, either lose money in real terms from a savings account, or take on more risk.

Bridging the gap

This sets the scene for the rise in popularity of an alternative to fixed rates bonds - the structured deposit. While investing inevitably involves putting your capital at risk, the structured deposit offers the potential for higher returns but without risking your capital, thereby providing a middle ground for savers that offers them the opportunity to enhance the overall returns from their capital.

Therefore, this product provides the peace of mind that capital protection brings to savers and can also be used for both new Cash ISA money as well as Cash ISA transfers, therefore placing it firmly in the savings space as a potentially viable alternative to the more traditional fixed rate offerings.

Main features

Structured deposits are essentially a combination of a deposit and an investment product where the return is not guaranteed but rather dependent on the performance of some underlying asset. The underlying investment is normally either an Index, such as the FTSE 100 Index, or a smaller number of shares from within the Index.

UK structured deposits naturally lean towards the FTSE 100 Index as this is the most commonly quoted benchmark of investment performance and is the most familiar to investors in this country. If the deposit uses a smaller number of shares rather than the Index itself then these are normally listed in the FTSE 100 and are often the larger and better known shares.

Capital Protection

When considering viable alternatives, the starting point for many savers is to protect their initial capital, which is why all structured deposits are fully capital protected. One of the key features is their status as deposits and the security and peace of mind that this entails. This is also why they are seen to sit alongside fixed rate bonds as a genuine alternative for savings.

This status brings with it the need to consider carefully which institution you wish to deposit your cash, as you would with any other savings product. The credit rating of the financial institution should be seen as an important factor and since this can be a complex and subjective area, the use independent rating agencies such as Standard & Poor’s provide us with valuable guidance.

Where do they sit in the range of options available?

The deposit provides the capital protection, whilst linking your return to the stock market replaces a fixed rate of interest with the potential for a higher return. The downside is that if the index does not perform in the way required to produce the stated returns, unless there is a minimum return you will only receive a return of your capital.

This is one of the main differences between structured deposits and fixed rate bonds. With the latter, your returns and the maturity periods are fixed whereas structured deposits have variable returns, and in some cases, variable maturities as well. Combined, this provides a middle ground in between a fixed rate bond, where your capital and return is guaranteed, and an investment where your return is not guaranteed and your capital is at risk.

Similarities with fixed rate bonds

Other similarities with fixed rate bonds are that structured deposits are meant to be held to maturity since your capital is designed to be repaid in full only at this time. If you withdraw your deposit before the maturity date you may lose part of your return and/or capital.

Deposit status also means that these plans are eligible for the Financial Services Compensation Scheme which offers protection up to £85,000 per individual, per institution.

Why such an increase in popularity?

One of the major factors leading to an increase in the use of such alternatives has been the over-reliance of fixed rate bonds by savers who are now seeing the real value of their savings eroded at a time when they need it most.

Structured products combine capital protection with the potential to receive higher rates than are currently available from fixed rate bonds, and to even beat inflation. These are difficult times to say the least and it is the saver who is enduring the harsh reality of this more than anyone. Understanding the impact of low rates, especially over time, and giving full consideration to all of the options available, particularly using your Cash-ISA allowances, are all reasons which have given a deserved spotlight to structured deposits.

Wide range of options

One final point which also contributes to the rise of the structured deposit is the wide range of choice available in their design, be it the need for income, growth, or a combination of the two. This is certainly a major positive and allows the products to move with the economic climate, something outside of the control of fixed rate bonds.

However this should also bring with it a word of caution. With flexibility in design comes a wide range of complexity in how each product works and you should be sure you fully understand the product before proceeding. The product brochure provides the main starting point and we at Fair Investment also produce our own individual fact sheet for each product and are always available to answer any questions you may have on the products themselves.

Cash ISAs remain important

With interest rates likely to remain low for quite some time, there has been an increasing trend of savers transferring their Cash ISAs to Investment ISAs as they are being challenged by the savings rates on offer to give up the security of cash for potentially better returns.

However, if you are considering this option you should be aware that once you have transferred to an Investment ISA you cannot transfer back to a Cash ISA. Since structured deposits are eligible for current year Cash ISAs as well as to receive Cash ISA transfers, they are also being used to transfer existing fixed rate Cash ISAs since this protects the Cash ISA status of your capital. Always remember to check whether there is any penalty to transfer before proceeding.

How do structured deposits compare with fixed rate bonds?

We have already touched on a number of similarities with fixed rate bonds and structured deposits have a few important characteristics that distinguish them from the more traditional savings accounts.

For a detailed comparison of these two types of savings plans as well as a summary of what you should consider before taking out a structured deposit, see our recent article comparing structured deposits and fixed rate bonds – what you need to know.

The bottom line …

Since the returns are not guaranteed these alternatives are not designed to meet the entire needs of every saver. What they do is provide a potential upside which could be a greater return than could be achieved by putting your money in a fixed rate bond for the same length of time with a similarly rated credit institution.

With the current market for all savings rates, regardless of term, offering very low rates by historical standards and the increased inflationary pressures on our capital, there would seem to be a strong case to at least consider these as a compliment to the more traditional fixed rate savings.

Compare alternatives to fixed rate bonds »

No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular investment. If you are at all unsure of the suitability of a particular investment, both in respect of its objectives and its risk profile, you should seek independent financial advice. Please note that tax treatment depends on legislation and your individual circumstances which may change in the future.

These are structured deposit plans that are capital protected. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In this event you may be entitled to compensation from the Financial Services Compensation Scheme (FSCS), depending on your individual circumstances. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index and any of it shares is not a guide to its future performance.

© Fair Investment Company Limited