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What dividends really mean for structured product investors


Colin Mclachlan, Technician, Lowes Financial Management

Almost all investment portfolios will have exposure to equities, whether that be through direct investment, collectives or through alternatives, such as structured investments.

A notable difference between buying a structured investment and investing directly in equities is the ability to earn regular dividends through the latter.

The FTSE 100 Index is currently yielding an average return of 3.79%, of which, the top paying share is BP Plc, paying dividends equating to 6.86%, closely followed by Provident Financial at 6.81%. However due to the current climate, competition and uncertainty, companies such as, Pearson, EasyJet, Sainsbury and Old Mutual have cut their dividends.

Structured products are typically linked to ‘price return’ indices like the FTSE 100 and may offer a return that reflects the percentage rise in the index/indices or, a pre-determined return provided the index performance meets certain criteria. The performance of a price return index will differ to a ‘total return’ version of an index. Accepting the effect of charges and tracking error, the performance of an index replicating tracker fund is more likely to reflect its total return index equivalent where the performance is made up of capital movements and the dividends paid on the underlying shares.

On the face of it, this might make structured products look like poor value compared to tracker funds, or investing in equities directly. However, whilst structured products investors don’t benefit from the regular stream of dividends, the estimated future value of these dividends is not lost but is instead factored into the structured product defined terms and returns. Whilst this could, for example be considered the trade-off for the contingent capital protection that the structured product affords over the tracker fund, it isn’t usually that simple. Depending upon market conditions and expectations, the future value of the dividends of the underlying components of the index could effectively provide more, or less than just the contingent capital protection.

As a company becomes more profitable they may increase their dividend, as this happens investors may be concerned that structured products become relatively poor value compared with an investment in the equities directly. However, an increase in expected dividend yields should enhance the returns offered by structures.

Of course, anticipated dividends are just one of the factors that impact the terms offered by a structured product. Other factors such as interest rates, market volatility and direction all play a part and movements in any of these can easily counter any change in anticipated dividend yield.

Therefore, whilst investors need to be aware that, when buying a structured product they will not benefit from a regular stream of dividends from the components of an underlying index, they should also understand that those dividends have played a fundamental role in facilitating the defined returns offered by the structure.

Structured products may not suit all investors, obviously, in particular those who are looking for equity exposure specifically to earn dividend income. However, we at Lowes Financial Management have proven that, when understood and used properly, they can add very good value to a well diversified portfolio.