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 need 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.
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 risk
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 give 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 so may not give 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.
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 give cost-effective access to diversified markets and give 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 give 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 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.
Also, 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.
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 as regular UCITS funds, and can invest in more illiquid assets like property. They give 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.
Important legal information
The Lloyds Bank Direct Investments Service is operated by Halifax Share Dealing Limited. Registered Office: Trinity Road, Halifax, West Yorkshire, HX1 2RG. Registered in England and Wales no. 3195646. Halifax Share Dealing Limited is 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.