CompareStructuredProducts.com - 06/09/2023
Contingent income plans offer a high regular income payment to the investor, generally on a quarterly basis but dependent on a position of the underlying index or stock. A generic FTSE 100 linked contingent income plan offered today will pay x% per quarter if the FTSE 100 is no more than 25% below the initial index level recorded on each quarterly observation date. If the index is below this level then no income will be paid for that quarter.
What contingent income plans offer therefore is a fixed level of income dependent on the FTSE 100 performance and irrespective of the dividend yield of the FTSE 100 and other factors. Furthermore, contingent income plans offer a built-in capital protection at the end of the term if the FTSE has fallen by up to say, 35%.
Investors seeking an income are usually doing so for that guarantee and certainty, perhaps to meet known regular costs. Income through contingent plans will generally be higher than through traditional vehicles as compensation for taking on the conditional element with income subject to market risk. The tradeoff is acceptable where the investor is willing to possibly cede income payments.
It is typical for conditional income plans to include pre-defined annual or even quarterly kick-outs that mean the investment will terminate if say the FTSE is at or above 105% of its initial level on pre-set observation dates. This introduces another risk to investor’s income objectives where the maturity means they need to re-invest on potentially differing terms.
Looking at historical backtesting since 1984 of a maximum 9 year FTSE 100 linked plan with a 65% end of term barrier, annual 105% kick-out observations, we can demonstrate how long contingent income plans will typically pay an income for.
|Total possible start dates:||10280|
|Of which, yet to reach 1st kick-out||507|
|Total possible maturity dates||9773|
Total number of maturity outcomes (% of total possible)
Historical backtest with 105% annual kick-outs
|Matured 2nd year||6393 (65.4%)|
|Matured 3rd year||865 (8.9%)|
|Matured year 4-8||1358 (13.9%)|
|Matured final year||488 (5.0%)|
|Matured with a loss||93 (0.95%)|
|Yet to mature||576 (5.9%)|
Just 5.95% of historical start dates would have seen the plan run to the final year with 0.95% of these witnessing a breach of the capital protection barrier resulting in less than invested capital being returned.
Over 65% of historical start dates would have seen the plan terminate on its first observable date thereby cutting the income payments short and forcing reinvestment. On the flip side early maturity dates for income plans add protection from risk of loss. This highlights a fine line between capital protection focus and a consistent income stream.
Backtesting indicates that reducing the kick-out level to 100% of initial index level, rather than 105% significantly increases the likelihood that maturity occurs on the first possible observation whilst reducing the chance of the plan running the full 9-year term. There is however only a small improvement on potential for capital loss.
Historical backtest with at-the-money annual kick-outs
|Matured 2nd year||7191 (73.6%)|
|Matured 3rd year||725 (7.4%)|
|Matured year 4-8||1433 (14.7%)|
|Matured final year||138 (1.4%)|
|Matured with a loss||72 (0.74%)|
|Yet to mature||214 (2.2%)|
If we increase the required kick-out level to a 10% rise in the FTSE 100, the possibility is an extended income paying term, yet with only a marginal increase in historical losses when compared to a 105% level.
Historical backtest with 110% annual kick-outs
|Matured 2nd year||5434 (55.6%)|
|Matured 3rd year||1021 (10.4%)|
|Matured year 4-8||1388 (14.2%)|
|Matured final year||916 (9.4%)|
|Matured with a loss||99 (1.01%)|
|Yet to mature||915 (9.4%)|
The lower likelihood of an early termination through a higher kick-out level will however translate to a lower potential return.
The first FTSE 100 linked contingent income plan matured in February 2008, offered a potential 10% annual income over the 3-year term, providing that the FTSE 100 did not rise or fall by 10% or more over the annual measurement period. The FTSE level was reset on each subsequent anniversary date. Being a capital ‘protected’ plan, after three years, invested capital was returned in full but no income was paid – at all!
All of the next 328 FTSE contingent income plans to mature since, paid an income in some form, ranging from 4% – 55% over their terms, with all returning capital in full, albeit 90 of these were deposit based so no risk of loss.
The 239 capital at risk contingent income plans realised an average annualised return of 5.73% over an average term of 3.9 years.
143 of these had potential to mature early based solely on the level of the FTSE 100 on maturity trigger dates. 141 of these plans did in fact mature early thus stopping future income payments and returning invested capital in full. On an average annualised basis the 143 FTSE 100 contingent income kick-out plans returned 5.69% over an average term of 2.6 years, this translates to an average total income paid for the 143 plans of 15.8%.
By comparing those with potential kick-outs to those without, the 96 plans without potential early maturity gave average annualised return of 5.78% over 5.8 years, translating to 38.7% in average total income.
The backtesting data clearly correlates with the actual performance seen in that given the chance to kick out if the FTSE rises it will do, therefore providing income for a shorter period. For an investor requiring a regular income over a fixed period, it is clear that plans with possible early maturity will see the income stream end early. The upside is that there is regular issuance of contingent income plans therefore helping investors’ reduce reinvestment risk.
FTSE 100 contingent income plan maturities 2008 - Aug 2023
|Capital at risk||Deposit-based|
|Number maturing at a gain||239||89|
|Number maturing at a loss||0||0|
|Number returning capital only||0||1|
|Average annualised returns||5.73%||4.53%|
|Average term (years)||3.90||5.18|
|Average advertised maximum term (years)||7.09||5.19|
Structured products put capital at risk.
Past performance is not indicative of future results.