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How’s your reality?

Ian Lowes - 11/01/2017

"You can think about something in one way for a long time and it seems like the only way to think about it, but it really isn't. Somebody could make a suggestion that really sounds naïve. It might even be naïve, but it could have an important element of the truth in it. And it could be truth that one's overlooking." Edward Witten

Six years ago in an article for a magazine I drew attention to some recent structured product maturities, the results of which will have come as a surprise to those that had a negative opinion of the sector.

These were not isolated examples but representative of the results the sector had been producing, whilst not exposing investment capital to undue risk. However, in recognition of the fact that past performance is not necessarily an indicator of the future, in the article I drew attention to three products then on offer that we were recommending to our clients and as such, that I believed would produce equally attractive results.

The last of these three investments has now matured so it seems fitting to review their performance and that of the sector over the six years since.

The first investment, the Incapital Europe Digital Growth Plan - FTSE 100 Index Series III was a six-year investment that matured on the 12th December. It was designed to return a fixed gain of 65%, provided the FTSE 100 Index was at, or above the initial index level, which was recorded as 5813. The plan was designed to return at least the original capital unless Santander UK defaulted or, the FTSE was below 2906.5 on the maturity date – both scenarios being something I would expect most people to accept had a low probability of occurring. As it was the bank is alive and well and the FTSE closed way above the required level resulting in the plan producing the defined 65% gain at maturity.

The second plan discussed, was the Legal & General FTSE Growth Plan 7 which also offered a fixed potential gain at maturity albeit at the lower level of 50% in part because it had a stronger counterparty but also because it had a reduced investment term of five years. Again the plan was designed to return at least the original capital unless the bank, HSBC in this case, went bust or, the FTSE had lost more than half its value at the maturity date. This investment matured in January 2016 when the FTSE 100 was less than 1% higher than it was when the investment began and yet that was enough to dictate investors would achieve the 50% gain.

The Morgan Stanley FTSE Kick Out Growth Plan 7 was the third plan that I suggested in the 2010 article and it was the last to mature. This didn’t fare quite so well as the best case scenario was for this plan to mature in December 2013 which it would have done if the FTSE was 10% higher than at the commencement of the term. Unfortunately, that maturity trigger was missed meaning that the plan would run for the full six years. At maturity it paid 1.3 times the rise in the FTSE 100 Index over the six-year term; the index rose 18.90% and therefore the plan produced 24.57% gain. Incidentally, there were a total of 15 such plans issued by Morgan Stanley and only this one and one other, failed to achieve the perfect result of an early maturity with a substantial return. Again however, none would have produced a loss unless the FTSE closed at the end of their respective six year terms at levels not seen since the early 1990’s or, the bank had defaulted.

Another notable maturity in our client portfolio’s this month is the Gilliat UK Growth Multiplier which is returning an 80% gain at the end of its six-year investment term. The fact that many of our clients who invested in this plan did so with maturity proceeds from a previous investment which matured in 2010 with a 70% gain makes it even more pleasing as they have more than tripled that element of their investment portfolio.

These are not extreme examples. We have been bestowing the virtues of structured products for a long time, spurred on predominantly by a degree of disbelief that others don’t see what we see, for whatever reason.

If the above results are not convincing enough, let’s examine all the IFA distributed, capital-at-risk structured product maturities that have occurred since my 2010 article was published.

Since then there have been no less than 1341 maturities. Of these, 902 were linked to the FTSE 100 only and the rest linked to more than one index, a basket of shares or, other assets.

The average annualised return produced by all of these products was 7.92% over an average term of 3 years and two months. The top twenty-five percent produced 12.52% per annum and the bottom twenty-five percent still returned an average of over 3% per annum. Of the 1341 maturities, 47 returned a loss but only one of these was a FTSE 100 only linked investment.

So given that these investments have produced such good returns whilst not exposing the capital to undue risk, why are they not more mainstream? It is still my opinion that many in our profession are yet to experience what I have dubbed as ‘that Tesla moment’ – if you haven’t experienced it yet you will and whilst it may not be in relation to structured products, it can be summarised as that moment when you realise that you’ve been missing something that makes so much sense.

As far as current structured products / investment strategies are concerned one of my favourites is of course one which we conceived ourselves – The 10:10 Plan from Mariana Capital. We do have a commercial interest in this plan but keep an open mind and hopefully you’ll agree that it represents a creditable investment option.

The 10:10 Plan differs from the mainstream products in that in adverse market conditions, it will not mature unfavourably after six years but will instead keep going for as many as ten years. The defensive option will mature on the first anniversary (from the third onwards) that the FTSE 100 is at least 90% of where it was at the beginning of the investment term. On a triggered maturity investors will be rewarded with a gain of 7.3% for each year the investment has been in force. Therefore, if the FTSE 100 is 15% below the initial level on the third anniversary but only 5% below on the fourth, the 10:10 Plan will mature returning original capital plus a 29.2% gain.

Only in the event that the FTSE is more than 10% down on every relevant anniversary would the plan run for the maximum ten-year term when, if the FTSE 100 Index is above the 90% threshold the Plan will mature with a gain of 73%, if the index is more than 10% down, but not more than 30% down, it will simply return the original capital, but if it is more than 30% down the investment will track the fall in the index. Counterparty risk is diversified amongst four ‘A’ rated financial institutions, significantly reducing the risk of a catastrophic loss arising in the event of a single bank failure.

Past performance is not a guide to the future but its still comforting to note that, over the history of the FTSE 100 index the defensive option of the current 10:10 Plan represents an investment strategy that would never have failed to produce a gain at maturity. How does that statistic compare with other investments you may be recommending?

Ian Lowes

Lowes Financial Management