A reader has sent me an invitation to invest in the HQX Fixed Rate Income Plan. It sounds really nice. I love the words "fixed income". Who doesn't? And this fixed income seems particularly lovable, for the simple reason that the first line of the detail suggests that your return is fixed at 9.36% a year for the next two years.
You won't be surprised to find that there is a catch. Read down a few lines and you find that while you will be paid 2.34% of your capital on eight payment dates over the next two years (assuming no bankrupt counterparties, and so on), the odds of getting your original capital back aren't quite so good. It turns out that the HQX Fixed Rate Income Plan isn't actually a fixed-rate income plan, it's an equity derivative product, the value of which is based on the future value of three equities HSBC, Vodafone and BP.
If, in two years, the final price of just one of these three stocks is less than 80% of its price on the start date, your capital will be reduced accordingly. So, if HSBC and Vodafone go up 50% but BP falls 30%, you will lose 30% of your total capital.
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That's not all. While you are financially punished if one falls, you won't be rewarded if they all go up (this is another variant of the win-win structure that works so well for hedge fund managers). They could all rise 50% and you'd still get no more than your 2.34% a quarter. It is also worth noting that despite the fact that you are making a bet on the prices of these shares, you won't receive any dividend payments. So no 4.1% yield from HSBC, no 5.5% from BP, and no 5.2% from Vodafone.
In summary: you've given up your upside, accepted a nasty downside, taken on counterparty risk and locked up your money for two years, all for not much more than 4% a year.
Let's go back to that downside. Perhaps you think it isn't very likely that any of these three shares could move down by 20% in the next two years and that it therefore isn't very likely that you could lose any of your capital. I doubt a MoneyWeek reader would be that dim, but look at how they have moved in the last year. The difference between HSBC's 52-week high and low is 34%. For Vodafone that number is 23% and for BP it is 14%. Right now they are all nearer to their highs than their lows, but the key point is that these big-name stocks are much more volatile than you think.
Betting none of them will fall 20% over a two-year period in which there is not just huge stock-specific risk but unquantifiable market risk (markets remain hostage to monetary policy) is completely insane.
This particular offering of extreme risk masquerading as security is unusually awful, but the market is still full of these products. I had rather thought that once their inventors were no longer able to bribe financial advisers with commission to shovel them into their clients portfolios, we would have seen the back of them. But no.
I have another on my desk from Socit Gnrale. It asks you to take a similar, if more complicated, bet on BT, Rio Tinto and Tesco shares in June for the next six years. It's more complicated because the income is hostage to the equity performance, along with the capital.Providers of these so-called structured products can all complain below. My core message to everyone else is this: you worked hard for your money. Don't risk it on silly products such as these. Just don't.
Here's a better idea. If you buy one of the products mentioned above, essentially a bet that stocks that have gone up a lot won't go down a lot, you are running a big risk of a hefty capital loss. Instead, why not bet that stocks or markets that have already gone down a lot might go up? You could still make a hefty capital loss, but you also have a much greater chance of making a major capital gain too. One you get to keep. Either way, you get to keep your own dividends.
What could such things be? I'm keeping a close eye on China. I have often written there that I expect a hard landing in China, and also noted that hard landings in commodity-consuming countries aren't great for commodity prices or commodity-producing countries. But in the past few months, this has gone from being a minority view to being an intensely held consensus opinion. A year ago, everyone was a China bull. Now everyone's a China bear. Chinese stocks are at a four-year low, although they're still not cheap enough for me to overlook the deficiencies of the stock market.
And the miners have been properly bashed. GlencoreXstrata is down 32% since September alone and now offers a dividend yield of 5%, which is some compensation for the risk inherent in holding its shares. Rio Tinto is much the same down 26% and yielding 4%. Not a stock picker? You could buy BlackRock World Mining Trust, a diversified mining investment trust which yields 4.5% and trades at a discount of 6.9% to the value of its assets, or, if you're really daring, Baker Steel Resources Trust, which holds junior mining and pre-IPO (initial public offering) stocks. It's down over 50% over the past year and trades at a yawning 38% discount to its net asset value.
This article was first published in the Financial Times.
