Findings published by the FCA beg the question, are firms are doing enough to ensure that customers understand structured products before investing?
The FCA last week published a behavioural economics research paper on the returns that investors expect from structured products. The research, based upon a survey of 384 investors, most of whom had previously bought structured products, demonstrates that many consumers overestimate the likely returns from such products, and struggle to make objective comparisons with more straightforward alternatives.
The research found that, when asked to anticipate how the FTSE 100 would grow over time, investors gave answers that were in line with the FCA's assumptions. However, when asked to anticipate returns on structured products based on that benchmark, investors significantly overestimated the expected returns. Similarly, investors struggled to appreciate that the structured products used in the research were unlikely to offer better returns than fixed-term cash deposits, and needed to be offered relatively high rates of return on risk-free deposits in order to prefer them over structured products. The research noted that disclosure of likely product returns and risk led investors who had initially overestimated returns to correct their views.
The FCA also looked at how a sample of firms design and market structured products, and concluded that firms are not always driven by the needs of consumers. The FCA concluded that firms need to ensure that they: identify a clear target market during the product design stage; only design products with a reasonable prospect of delivering economic value to customers in that target market; ensure that customers are provided with clear and balanced information on products and any risks; and strengthen lifestyle monitoring in relation to these products.
While the FCA believes that existing guidance to firms in relation to the development of products is clear, it has indicated that if the market does not show firms responding to these findings it will consider further regulatory action. The FCA fined two firms over the misleading promotion of structured products in 2014 and clearly takes this issue very seriously. Firms are advised to bear the FCA's comments in mind when designing and marketing structured products, and to ensure both that such products are only offered where appropriate, and that investors are made aware of all of the risks of, and likely returns from, such products before investing.
The study of behavioural biases in investors, and how these biases apply in relation to different product features is clearly an important area for further research. There is an obvious risk to consumers inherent in products with features that can exploit these biases, and the FCA needs to continue to work to understand these biases in order to ensure investors are making objective investment decisions. This is particularly the case in light of the forthcoming pension freedom reforms, which will give many investors access to significant sums for investment.