Not all structured products are evil – here are four to consider.
“Structured products.” I suspect I just have to say these two words and more than a few of my colleagues at MoneyWeek will be reaching for their crucifix and garlic. Critics of structured products are legion. There are two main charges against these products: firstly, that they are opaque and designed to ensure a bad deal for the investor.
Secondly, that they contain all sorts of hidden risks – mainly counterparty risk, as a result of entering into a contract with an investment bank that could go bust (such as Lehman Brothers in 2008). Given these concerns, say the critics, just buy a stockmarket tracker and be patient.
Are these criticisms fair? My view is that it depends on the product. Some structured products are rubbish (many are sold on the high street by our wonderful building societies). But others can work well. I’ll admit upfront that I am not a disinterested observer. I’ve used structured products in my own portfolio and so far I’ve been 100% happy with them – although maybe I’ve just been lucky.
Also, I’ve looked at hundreds of different products over the last decade as a financial writer and in the last year I’ve also written up objective performance data for the structured products industry’s own website. So far, the data are encouraging – it suggests the vast majority of products issued in the last few years have produced solid returns measured against key benchmarks, with very few complete disasters.
An innovative ‘kick-out’ plan
So you should judge the individual product, not the entire asset class. On that basis, I’d take a look at a new “kick-out” plan from Ian Lowes, an independent financial adviser in the North East. Lowes runs his own advisory firm with over £600m in assets. While less than 20% of his clients’ money is invested in structured products, I think it’s fair to say he can be a little obsessive about these investments. In recent years he’s been quietly educating advisers via his website StructuredProductReview.com.
Having looked at more than his fair share of poorly constructed structured products, Lowe decided to design his own with the help of industry expert Chris Taylor (formerly of InCapital Europe). They’re both level-headed, smart guys – I’m not sure I agree with everything they say, but they know what a bad investment looks like, which in turn helps explain why their first product together is so interesting.
It’s called a “kick-out” or “autocall” plan. The strategy behind these is simple. Take an index such as the FTSE 100. The plan starts (in the case of this product, in early October) by referencing the level of that index at a particular point in time – let’s say it’s 6,000 on 15 October 2015. With this product, we then jump forward three years. If the FTSE 100 is at or above the index level (in this example, 6,000), your product “calls” – finishes or redeems – and you get your initial capital back, plus (in this case) a 10% capital gain for each of the three years, ie, a 30% gain. That 10% annual return is a capital gain, and so is not taxed as income. This particular product is called the 10/10 Kick-out plan – ten years, 10% per annum (you’ll see why it’s ten years in a moment).
But what if the FTSE 100 hasn’t hit 6,000 on the three-year mark? It’s entirely possible. In that case, our product can’t call, so we move on to year four, 15 October again. If the index is above that 6,000 starting level, your product calls and you get four years of 10% capital gain rolled up as one gain – a 40% profit. And if the target isn’t hit in year four, you shuffle on to year five, and so on for a total of ten years. If the FTSE 100 hit above 6,000 on the specified date in year ten, then you’d get ten times that 10% a year capital return – a 100% gain.
If the required kick-out (or trigger) level isn’t hit at the end of the ten years, the original capital is returned in full, unless the index is down by 30% or more, in which case the capital is lost in line with the fall in the index. So if the plan has not matured on a previous anniversary and if, after ten years, the index is 40% lower than its start level, then 40% of the original investment will be lost.
The risks and rewards
As kick-out plans go, this is all fairly standard, but the unique feature is that ten-year period. In effect you are being given a very long period of time to make a bet on equity markets. The chances of the FTSE 100 not being above its October 2015 level in 2025 are surely very low. Yes, stockmarkets are volatile, and the next crash (and there will be one, as QE unwinds properly) could easily see a collapse of 40% or more within those ten years. But this product is only worried about the index level at the end of ten years. That might happen if we had two back-to-back “black swan”-style crashes – possible, but not probable.
Another risk is that the payout is in turn based on a series of underlying options issued by French bank Societe Generale, working with the “plan manager” Mariana. Just because the counterparty is a big investment bank, doesn’t mean it can’t go bust. However, given the French government’s reliance on its small number of big (part-state-owned) banks, this seems unlikely – though not entirely impossible.
So there are risks, but I think the upside rewards are also fair. That 10% annual return is more than acceptable. You may get a bigger return from investing directly in equities, but that’s the essence of structured products – you give up some upside in return for a defined return. You also don’t have to worry about day-to-day volatility. Of course, you have to lock up your money for at least three and maybe as many as ten years – you can’t ring up halfway through and ask for it all back. But for those who can lock up the cash and want a more cautious equity-based investment option, that trade off may appeal.
The 10:10 Twin Option FTSE Kick-Out Plan comes in two forms. The first offers that 10% potential annual return, if the FTSE 100 is at or above its start level at any anniversary (Option 1), or a 12.5% potential annual return if it’s at or above 110% of its start level (Option 2). Any charges are accounted for in the terms of the plan. The issuers say these aren’t expected to exceed 3.5% over the ten-year maximum investment term. For details, see Lowes-sic.com or MarianacCapital.com. The closing date for investments (via an adviser) is 14 October.
There are a few other structured products you might want to investigate. Reyker Securities is a newish small player. Its latest product is the Securities FTSE 100 Supertracker Plan October 2015. This uses Royal Bank of Canada as the counterparty and offers a return of ten times any positive FTSE 100 growth, to a maximum of 80%. This may appeal to those who want to be able to make big returns from a relatively small move in the market. Another product is the Walker Crips Annual Growth Plan (Issue 35), which has a kick-out structure, and uses Goldman Sachs as its counterparty. In return it offers a potential 8.5% a year from year two, if FTSE 100 index is at or above its starting level.