To show you this page, we placed cookies on your computer. If you continue on this website, we will use further cookies to maximise your experience and help us to understand how we can improve it.

Learn More I understand, please dismiss this notification

Back

A Bird in the Hand - Hold or Sell? The Positives and Negatives of Surrendering a Structured Product Early

Ian Lowes, founder of CompareStructuredProducts.com - 01/04/2015

A version of this article was first published by New Model Adviser

One of the old myths of structured products is that they are an illiquid, ‘buy-and-hold’ investment. Indeed, they are ‘structured’ to provide defined returns at pre-defined maturity dates and investors should commit to those terms but that does not mean that early surrenders are not possible or, in some cases advisable. This article will explore the decision process when considering selling out early or, holding onto a structured product until maturity.

So what influences a structured product’s secondary market price? It represents the value attributed to the product at any point during the life of the investment and essentially, the same factors that influence the pricing of other investments will determine that value: the price of the underlying relative to its strike value, volatility, interest rates, time to next possible maturity date etc.

Let’s look at an example. The Legal & General FTSE Growth Plan 1 was launched in late 2009 in the aftermath of the market crash of 2008/09, and ultimately ‘struck’ at a FTSE 100 position of 5530. Remember this was a time when we were still in the grip of a global crisis and anyone who suggested they had a solid expectation of what was going to happen next or, where the markets were heading over the short to medium term, were exercising little more than guess work. The fact that the Legal & General plan was backed by HSBC, one of the strongest banks having been relatively unscathed by the crisis compared to many others, was in itself an attraction.

Furthermore, whilst it was hoped by most that the worst of the crisis was over and that markets would continue to recover, the investment had a 50% barrier which, based on the market levels at the time the plan was offered meant that in order to give rise to a loss at maturity from market movements, the FTSE 100 level at the maturity date in July 2015 would have had to have fallen to levels not seen since 1992. Given the economic uncertainty at the time, the failure of the bank or such a catastrophic collapse in the market was not an impossibility but from a risk management perspective, considering how other investments would be affected in such circumstances, the Legal & General plan was not an unreasonable investment proposition by any stretch of the imagination.

So what about the upside? Quite simply, the investment offered a 62% gain at the end of the five-and-a-half year period if the FTSE 100 was higher than it was at the beginning of the term. So with Bank of England base rate at 0.5% here was an investment that could mature after 5.5 years producing an annualised return of 9.15% on the back of a FTSE rise of just 0.1%.

Whilst the value of the 50% barrier should not be ignored, based on a strike level of 5300, assuming that a FTSE 100 index tracker would achieve an additional 3% per annum growth over the actual index level from dividends net of charges, it was recognised that a tracker would out-perform if, at the end of the term the FTSE had risen above 7,630 points. This of course was not an impossibility but at that time there were few that expected to see the index reach that level any time soon.

The decision to utilise the FTSE Growth Plan has thus far, proven to be a sound one but is it now time to consider selling out early? We are currently just over 3 months away from the maturity date and based on the latest surrender price investors would realise a 55% gain. At the time of writing the FTSE has risen by 23% over the investment term to date and as such, it will mature in early July producing a 62% gain even if the index falls by 18.5% between now and then. To produce a loss on original capital at maturity, either HSBC would have to default or, the FTSE would have to fall by almost 60% and whilst these events are unlikely, a 20% fall over the next three months is far from impossible.

So the decision is whether to ‘cut-and-run’ realising a healthy 55% gain on the original investment (acknowledging that a £90 dealing charge will apply) or hang on for another 15 weeks in the hope that the market will not fall by more than 18.5% and as such the investment will produce the 62% gain. When considered in isolation, by reference to the current surrender price, this represents a return equivalent to 16.5% per annum over a 15 week holding period which will be achieved even if the FTSE falls by 18.5%. But conversely, if the index closes below 5530 on 6 July investors will only get £1 back for every £1 invested and will no doubt will wish they had cashed in and achieved the £1.55.

Obviously the right course of action for any individual will depend on their personal circumstances, the reason for the investment, the range of their other investment assets and perhaps more importantly, what they expect to do with the proceeds. But as ever, the definitive answer as to what the right course of action to take is will not really be known until we have the benefit of hindsight. Whilst I welcome the flexibility of having the option to sell out early, I for one will be holding onto mine until its pre-defined maturity date in July.

giraffe Do you need any help?