What Are Structured Deposits And Why Are They Proving So Popular
14 May 2013 / by Oliver Roylance-Smith
With the current market for fixed rate savers at one of its lowest points, and the future outlook not much better, making sure that we understand all of the options available to us is more important than ever before. With this in mind, we take an in-depth look at structured deposits to see why more and more savers are starting to see their appeal.
The last month has seen a continuation of the all too familiar backdrop of economic uncertainty. The record low Bank of England interest base rate remains at 0.5% (as at 9th May 2013), well into its fourth year, and although the UK narrowly missed out on a triple dip recession, nobody should be fooled into thinking this means recovery. The Confederation of British Industry got excited earlier this week at the prospect of the UK economy growing 2% in 2014 – hardly a cause for optimism when viewed in the context of what is required to fuel our recovery.
All household incomes are under pressure, and with the real inflationary threat still an unknown quantity, we should be wary of what is around the corner. The days of a sustained recovery still remain firmly off the radar for the foreseeable future, but what about those who are in need of a decent return from their hard earned savings – what is the market offering them?
The mainstay of many a saver’s portfolio has historically been the fixed rate bond. However, rates here have been under continued pressure and this has taken hold of the market, which has reacted by offering generally lower yields. In fact, this is probably one of the worst times to be comparing rates in order to get a competitive deal.
Gone are the days where committing your money for longer was all you needed to secure a higher rate with the potential to outstrip inflation. Currently, anything around 2.50% is considered a best buy. Although higher rates are available, you will need to fix for 5 years and 3% is likely to be the best on offer.
One of the major downsides of tying up your money is that if rates start to pick up, you can only get out by accepting some form of penalty. But how long do we wait – 6 months, a year? Certainly, many of us have suffered low rates in the hope things will change soon, but we are still suffering the effects of the record low 0.5% Bank of England interest rate which has been with us since March 2009.
With the prevailing economic consensus being that interest rates will remain low for some time, this bleak outlook requires our urgent attention.
Without a doubt, fixed rate bonds are an important part of the savings jigsaw, but their status as the only option should be carefully considered in light of the economic reality that continues to affect every saver in the UK. This is challenged further by the reduction in the fixed interest rate uplift achieved by committing your capital for longer.
As an alternative option to fixed rate bonds, interest in the structured deposit has continued to grow in this environment, combining protection of your capital with the opportunity to achieve higher returns than would be available from a fixed rate bond of similar duration.
Bridging the gap
When considering viable alternatives, the starting point for savers is of course to protect their initial capital, which is why all structured deposits are fully capital protected. These products combine capital protection with the potential to receive higher rates than available from fixed rate bonds and which also have the potential to beat inflation but without putting your capital at risk.
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. This flexibility in design results in a wide range of different types of structured deposits, increasing the product choices available.
Structured deposits are essentially a combination of a deposit and an investment product where the return is dependent on the future performance of an underlying asset, commonly the FTSE 100 or a number of shares listed within the FTSE 100.
By linking your return to the stock market and thereby sacrificing a fixed rate, you create the opportunity to receive higher returns. The downside is that if the index does not perform in the way required to produce the stated returns, you will only receive a return of your capital (unless there is a minimum return).
One of the key features of structured deposit plans is their status as deposits and the security and peace of mind that this entails. This security means that they can sit alongside fixed rate bonds as a genuine alternative for savings.
As with any savings product, it is important carefully consider your choice of institution when deciding where to deposit your cash. The credit rating of the financial institution in question should be seen as an important factor. Since this a complex and subjective area, independent rating agencies such as Standard & Poor’s can provide valuable guidance.
Other similarities with fixed rate bonds
Another similarity shared by fixed rate bonds and structured deposits is both 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 some 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. Although this does not distinguish structured deposits from fixed rate bonds, it does bring them on a level playing field.
Why such an increase in popularity?
Times have changed. The main reason for the shift in focus towards structured deposits has been the over-reliance of fixed rate bonds by savers – many of whom are now seeing the real value of their savings eroded at a time when they are most needed.
Structured products combine capital protection with the potential to receive higher rates than those available from fixed rate bonds, and they can even beat inflation. These are difficult times, to say the least, and more than anyone, it is savers who are enduring the harsh reality of this. Understanding the impact of low rates over time, and giving full consideration to all of the options available, particularly using your cash ISA allowances, are all factors which have given structured deposits a deserved place in the spotlight.
Wide range of options
One final point, which also contributes to the rise in popularity of the structured deposit, is the wide range of choice available – plans are available that are designed to provide income, growth, or a combination of the two. This is certainly a major positive, allowing the products to move with the economic climate, something that is outside of the remit of fixed rate bonds.
However, this flexibility should also bring with it a note of caution. With flexibility in design comes a wide range of complexity in terms of how each product works and you should be sure that you fully understand the product before proceeding. The product brochures provide the main starting point. At Fair Investment we also produce our own fact sheets and are available to answer any questions you may have on the products themselves.
The bottom line…
Since returns are not guaranteed, these alternatives are not designed to fulfil all the needs of every saver. However, what they do provide is a defined return over a defined timeframe, offering a viable alternative to other options currently available within the market.
With the current market for all savings rates – regardless of term – offering very little by historical standards, and inflation continuing to cause a headache with our net returns, there would seem to be a strong case to at least consider structured deposits as a complement to more traditional fixed rate savings.