Complex instruments
What you need to know before considering investing in complex instruments
What are complex financial instruments?
Complex instruments are types of investment considered more difficult to understand and are typically riskier investments than others, like funds. Investments in complex instruments are more likely to lead to poor outcomes for investors.
Some examples include leveraged instruments, some Exchange Traded Funds (ETFs), complex bonds, and warrants.
A complex instrument has certain features that categorise it as complex. This is typically one or more of the following:
It’s difficult to sell, redeem, or otherwise regain the money you have invested.
Prices are not publicly available or validated independently.
The investment includes a clause, condition or trigger that could fundamentally alter the nature or risk of the investment, or the amount of money to be paid out to you.
It includes an exit charge that may make the investment harder to sell.
It may be possible to lose more money than you originally invested. Although HL does not list any instruments with this feature, so you cannot lose more than 100% of the money invested with HL.
It’s not traded on a regulated market (for example, The London Stock Exchange’s main market). HL only lists complex instruments listed on a regulated market.
There is not enough information available on the investment to make an informed decision on buying or selling.
Because of these features, complex instruments may not perform as expected and the value of your holding could deteriorate over time. You should only consider a complex instrument if you’re a financial professional or a highly knowledgeable investor.
Investments can fall as well as rise, so you may get back less than you invest, if you are ever unsure, please seek advice.
What else should you consider before buying a complex instrument?
Complex instruments are sometimes designed to be held for specific periods of time. You can check this in the Key Information Document (KID).
The heightened risk and low liquidity often seen in these instruments means they may not be suitable for investors with a low-risk appetite.
Investing in complex instruments may expose you to larger losses and, especially for leveraged instruments, can lead to significantly different performance and greater volatility than expected.
Due to their complicated structures, a higher level of financial knowledge is needed to invest in complex instruments, and you should monitor your investments closely. This may also mean more regular rebalancing of your portfolio is needed to check it is still meeting your investment goals.
Complex instruments aren’t for everyone. If you’re new to investing or are looking for something less risky, then you may want to consider other options.
Questionnaire completion: checking your understanding
Before you buy a complex instrument, you’ll need to complete our online questionnaire (also known as an appropriateness assessment). It checks your knowledge and experience of the type of instruments you intend to buy.
While the assessment is required by the regulator (the Financial Conduct Authority), more importantly, it’s crucial that you understand the additional risks associated with this type of financial instrument.
There’s an assessment for each type of complex instrument, so if you’re intending to buy more than one type, you may need to complete multiple assessments. We may ask you to periodically complete the assessment to check you still understand the risks. Once you’ve completed the assessment, you’ll be able to buy the instrument with HL.
You can retake the assessment if you fail to meet the minimum requirements, but it’s important that you carefully read the risk information provided throughout the assessment and in the instrument’s key documents.
As with any investment, key risks and features of the instrument you’re intending to buy can be found in the Key Information Document (KID) and Prospectus (where applicable).
Some examples of complex instruments:
There are a range of complex financial instruments, each with different features and degrees of risk. Below are some of the more common instruments you might see.
Leveraged Exchange Traded Products (ETPs)
Leveraged ETPs, including leveraged Exchange Traded Funds (ETFs), are collective investment where investors’ money is pooled together into a single investment. These products are set up to track the short-term performance of an index or commodity (E.g. FTSE 100 or Gold). A leveraged ETP uses borrowed money to purchase financial products such as futures and other derivates to amplify the movements of the underlying index it’s tracking. For example, a leveraged ETP could change a 1x rise or fall in an index to 2x or 3x, or greater, depending on the amount of leverage used.
Here's an example:
Let’s take a FTSE 100 2x daily leveraged ETF as an example. This product aims to replicate 2x the daily percentage change in the FTSE 100 index. If the index rises by 5%, the leveraged ETF should rise by 10%. In this instance, the leveraged ETF has doubled the return (not accounting for charges incurred). However, as you may expect, leveraging can also multiply your losses. If the index falls by 5% the leveraged ETF should fall by 10%.
Here’s another example of what could happen during significant market volatility:
Let’s take the same FTSE 100 2x daily leveraged ETF as an example. During volatile market conditions, if the index falls by 20%, the leveraged ETF should fall by 40%, potentially almost halving the value of the initial investment.
The higher the degree of leverage, the higher the risk of loss.
Most leveraged ETFs reset to their underlying benchmark index on a daily basis to maintain a fixed leverage ratio. This means leveraged ETFs should not usually be used in a long-term investing strategy, as the product is tied to movements in a single trading day, meaning the instrument cannot build upon the previous day’s gains or losses.
Unsure if these investments are right for you?
Complex bonds
Complex bonds are those which provide a different risk/return profile than traditional bonds. There are several types of complex bond.
These have the same characteristics of a traditional bond, but they contain an embedded equity call option.
This means the holder has the right, but not the obligation, to exchange their holding in the bond into a set number of ordinary shares.
For example, holders can exchange the value of the bond for shares in the same company when the bond matures (the date the value of the bond is repaid in full). The option has intrinsic value when the share price has risen compared to when the bond was purchased, as the holder can exchange the value of the bond for shares in the company. These shares will have a greater value than the par value of the bond. However, if the share price has fallen, the holder may choose not to exchange as the bond value will be greater than the value of the shares. These bonds tend to pay a lower interest due to the embedded equity call option.
The par value and maturity of these complex bonds are linked to the rate of inflation. As a result, the coupon (interest paid) on the bond is usually low. The appeal of these bonds comes from the relationship between the forecasted, known as the implicit, interest rate and the actual interest rate. If the actual interest rate is higher than the implicit interest rate, the value of the bond will increase and vice versa.
Perpetual bonds and Permanent Interest-Bearing Shares (PIBS) have no fixed term or maturity date. Therefore, these bonds may not mature and are usually more sensitive to interest rate changes than standard bonds. However, perpetual bonds tend to pay a higher annual coupon than is usually offered with standards bonds. It must be noted that perpetual bonds can come with a forced repayment clause meaning the holder may be forced to repay the value of the bond after a specific date.
Complex Investment Trusts
Complex Investment Trusts have more freedom than non-complex Investment Trusts to invest in areas such as commodities, microfinance, and private equity. This means complex Investment Trusts carry a greater risk to the investor due to the reduced regulation around the trust’s investment strategy.