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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:

  1. It’s difficult to sell, redeem, or otherwise regain the money you have invested.
  2. Prices are not publicly available or validated independently.
  3. 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.
  4. It includes an exit charge that may make the investment harder to sell.
  5. 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.
  6. 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.
  7. 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?

  • Due to their complicated structures, complex instruments are usually designed to be held for specific periods of time, usually for the short term. 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 these instruments may expose you to larger losses than non-leveraged instruments and leveraging can lead to significantly different performance and greater volatility than expected.
  • The complex calculations and tax considerations mean 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).

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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 Exchange Traded Products (LETPs), including leveraged Exchange Traded Funds (LETFs), are collective investment funds where investors’ money is pooled together into a single investment. These funds are set up to track the short-term performance of an index or commodity (e.g. FTSE 100 or Gold). A LETF 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 LETF 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 LETF should rise by 10%. In this instance, the LETF 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 LETF should also fall 10%.

Most LETFs reset to their underlying benchmark index on a daily basis to maintain a fixed leverage ratio. This means LETFs 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.

Complex bonds

Complex bonds are those which provide a different risk/return profile than traditional bonds. There are several types of complex bond.

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.