Complex investments

 

What are complex investments?

A complex investment is a type of investment that includes features or structures that make it more difficult to understand, value, or manage compared to standard investments, such as stocks and bonds. 

These complexities can increase both potential risks and rewards, and typically require a higher level of investment experience and knowledge before trading them. 

Regulatory guidelines suggest that you should not invest more than 10% of your net assets in these higher risk, complex investments. 

Before trading in complex investments, you must complete an appropriateness test. This is to demonstrate that you have the appropriate knowledge and experience to buy this type of investment and that you fully understand the risks involved. 

Complex bonds

While not all bonds are complex, some may include features that add complexity. A complex bond may have one or more of the following features:

Subordinated bonds

When you invest in bonds, you’re lending money to the company who issued the bond typically for a set time period, and when the bond expires the original amount is paid back to you (unless the bond is perpetual). Along the way, you also receive regular interest payments. Subordinated bonds are like being at the back of the repayment queue. In the event that the issuing company went bankrupt, subordinated bondholders are only paid after other debt holders. Because of this higher risk, subordinated bonds typically pay higher interest rates to compensate for this.  

Key risks:

  • Credit risk: Greater exposure to credit risk, as subordinated bondholders are paid out after other debt holders in the event of issuer insolvency. You may only receive a partial repayment, or none at all if the issuer’s assets are insufficient.

Callable bonds

Callable bonds have a clause in which the issuer of a given bond can redeem (buy back) the bond before it expires (known as maturity). They return the original amount, but you may not receive all of the interest payments that you expected to if it is redeemed early. Callable bonds typically offer higher returns to compensate for the increased risks. 

Key risks:

  • Cash flow risk: The call element creates uncertainty around cash flows. The income stream from the bond is less predictable as it may be cut short if the issuer decides to redeem the bond early. 
  • Reinvestment risk: Exposure to reinvestment risk if the issuer redeems the bond early. You may miss out on expected interest payments and may have to reinvest at poorer rates.

Perpetual bonds

Perpetual bonds have no maturity date, meaning that the issuer never has to repay the original amount invested, but investors receive interest payments indefinitely. Perpetual bonds therefore provide consistent long-term income and may be useful for long-term income strategies. 

Key risks:

  • Credit risk: Because perpetual bonds have no set maturity date, you are exposed to credit risk indefinitely. If the issuer’s financial position weakens, they may defer or even skip interest payments. 
  • Call risk: Some perpetual bonds may also be callable, and therefore may not provide the expected long-term indefinite income if the issuer decides to redeem the bond. 
  • Interest rate risk: They are highly susceptible to interest rate risk; their price can fall sharply if rates rise. 
  • Inflation risk: Fixed payments lose value over time due to inflation, meaning perpetual bonds are highly susceptible to inflation risk.
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Synthetic exchange-traded funds (ETFs)

Exchange-traded funds (ETFs) are pooled investment funds that trade on stock exchanges. Synthetic ETFs do not buy the actual stocks or bonds in an index. Instead, they use financial contracts (known as derivatives) to replicate the performance of an index. Synthetic ETFs can provide cost-effective access to diversified markets and provide exposure to typically difficult to reach or illiquid sectors. 

Key risks:

  • Counterparty risk: Because synthetic ETFs use financial contracts instead of owning actual assets, they rely on the stability of the company providing those contracts. If that company – the counterparty – goes bankrupt, you could lose some or all of your investment.  
  • Tracking risk: Performance may not always completely accurately reflect that of the assets or market it is tracking.

Synthetic exchange-traded commodities (ETCs)

Exchange-Traded Commodities (ETCs) are investments that enable investors to track the performance of a specific commodity (such as precious metals, energy or agricultural products) or a broader commodity index. ETCs can be synthetic, which means that they aim to track the performance of the given commodity or commodity index using financial contracts (derivatives) rather than owning the physical commodity. They provide efficient access to commodity markets without physical ownership and are typically more liquid than direct commodity holding. 

Key risks: 

  • Counterparty risk: Like synthetic ETFs, synthetic ETCs rely on the use of derivatives and are also exposed to counterparty risk. 
  • Tracking risk: Performance may not always completely accurately reflect that of the underlying commodity. 
  • Market risk: Highly exposed to market risk, as commodity prices can be highly volatile and are often highly reactive to geopolitical events.

Exchange-traded notes (ETNs)

An ETN is a type of investment that works like a bond but trades on a stock market, like the London Stock Exchange. As an investor, you’re lending money to a bank or other financial company. They promise to pay you a return based on how well something – like a stock market index, oil, gold or currency – performs.

You don’t own the underlying assets - you just get paid based on how they perform. Unlike a bond, most ETNs don’t pay interest. You make money if the thing you track goes up – and lose money if it goes down.

Key risks:

  • Credit risk: If the issuer defaults, you could lose your entire investment, regardless of index performance. 
  • Liquidity risk: ETNs may be hard to buy or sell quickly, especially in volatile markets or if trading volumes are low. 
  • Call risk: The issuer may redeem the ETN early, potentially limiting your gains. 
  • Concentration risk: ETNs often track a single asset or index, increasing exposure to market swings.

Crypto exchange-traded notes (cETNs)

Don’t invest unless you’re prepared to lose all the money you invest. This is a high-risk investment and you should not expect to be protected if something goes wrong. Take 2 mins to learn more.


 

These are complex products that are not appropriate for all retail investors, if you are unsure you should seek independent financial advice. It is not recommended that you invest more than 10% of your portfolio. These products are highly volatile and are NOT FSCS protected.

 


Crypto ETNs (cETNs) are a type of ETN that track the price of a specific cryptocurrency, such as Bitcoin or Ethereum. They are traded on regulated exchanges and offer a way to gain exposure to cryptocurrencies without directly owning them. Instead of holding the digital asset, investors receive returns based on its performance, minus fees. They offer exposure to cryptocurrencies without the technical, security, or regulatory challenges of holding them directly. 

Because cETNs are debt instruments issued by a financial institution, your investment depends not only on the performance of the underlying cryptocurrency but also on the issuer’s ability to meet its obligations. If the issuer defaults, you could lose your entire investment, even if the cryptocurrency performs well. In addition, while cETNs are listed on exchanges, trading liquidity can never be guaranteed, especially during periods of market stress.

This may make it more difficult to buy or sell quickly, which may leave you exposed to sudden market swings. Furthermore, unlike the underlying cryptocurrency that they track, cETNs can only be traded during market hours.

 

Estimated reading time: 2 min

Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.

What are the key risks?

1. You could lose all the money you invest

  • The performance of most cryptoassets can be highly volatile, with their value dropping as quickly as it can rise. You should be prepared to lose all the money you invest in cryptoasset exchange traded notes. 
  • The cryptoasset market is largely unregulated. There is a risk of losing money due to risks such as cyber-attacks, financial crime and firm failure. 

2. You should not expect to be protected if something goes wrong

  • The Financial Services Compensation Scheme (FSCS) doesn’t protect this type of investment because it’s not a type of investment that the FSCS can protect. Learn more by using the FSCS investment protection checker. 
  • Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection.

3. Cryptoasset investments can be complex

  • Investments in cryptoasset-linked products can be complex, making it difficult to understand the risks associated with the investment. 
  • You should do your own research before investing. If something sounds too good to be true, it probably is. 

4. Don’t put all your eggs in one basket

  • Putting all your money into a single type of investment is risky. Spreading your money across different investments makes you less dependent on any one to do well. 
  • A good rule of thumb is not to invest more than 10% of your money in high-risk investments. 

If you are interested in learning more about how to protect yourself, visit the FCA’s website.

For further information about cryptoassets, visit the FCA’s website.

Non-UCITS retail scheme (NURS)

A unit trust is a type of collective investment scheme that pools money from investors to invest in a diversified portfolio of assets, such as shares, bonds, or property. A Non-UCITS Retail Scheme (NURS) is a type of complex unit trust. They are not subject to as strict regulation than regular UCITS funds, and can invest in more illiquid assets like property. They provide access to asset classes not normally available in standard funds.

Key risks:

  • Liquidity Risk: NURS can invest in assets that are hard to price or sell, such as property or unlisted securities. In stressed markets, you may not be able to redeem your investment quickly or at a fair price.  
  • Valuation Risk: The value of underlying assets may be subjective, especially for property or private assets.  
  • Concentration Risk: NURS may invest more heavily in certain assets or sectors than standard UCITS funds, increasing risk.

The value of investments, and income from them, can fall as well as rise and you may get back less than you invest. If you're unsure about investing, seek independent financial advice. There may be a charge for that advice.

Important legal information

Scottish Widows Share Dealing Service is operated by Halifax Share Dealing Limited. Registered in England and Wales No. 3195646. Registered Office: Trinity Road, Halifax, West Yorkshire HX1 2RG. Authorised and regulated by the Financial Conduct Authority under registration number 183332. A Member of the London Stock Exchange and an HM Revenue & Customs Approved ISA Manager.

Important share dealing information