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Income for Gold? - 29/09/2016

Both the Olympic and Paralympic Games in Rio proved to be enthralling spectacles for fellow sports fanatics and armchair enthusiasts. Both events resulting in Team GB exceeding medal expectations due to the true grit and determination of the participating athletes. The British athletes excelled in Rio in both games beating the overall medal haul of the 2012 home games in London.

The USA were the only participating country involved in the Olympic games to outshine Great Britain & Northern Ireland. Nevertheless, Team GB’s performance lead to 27 Gold 23 Silver 17 Bronze, a total medal tally of 67. The Paralympians also had a very productive time out in Rio producing 64 Gold 39 Silver and 44 Bronze, a total tally of 147.

What do the achievements of Team GB and structured products have in common? Well it’s tentative but the recurring medal haul could be likened to that of contingent income bearing products which potentially provide fruitful results on a recurring basis (normally quarterly) if the underlying Index is performing in line with the product’s pre-defined terms.

Unlike growth investors, income investors seek the rewards from their investment throughout the intended investment term, whether that be to top up disposable income or to help with ongoing expenses. Throughout ‘the games’ i.e. the term of the product, ‘medals’ i.e. income is awarded if the ‘team’ i.e. underlying index, performs appropriately. However, with certain products, if the underlying index performs well enough the ‘games’ are brought to an early close. But of course there is a ‘capital at risk’ aspect of structured investments that, in the worst case could result in getting to the end of the ‘games’ and then having to give back all your medals and more.

Two contenders currently on offer which may appeal to an investor seeking income are:

The Meteor FTSE Dual Option Contingent Income Plan October 2016 – Option 1, is a maximum six-year and two-week structured investment which aims to generate gross quarterly income payments of 1.25% (5% annually) on the invested capital. Income will be paid provided that on each of the quarterly observation dates, the FTSE 100 Index closes at a level no more than 40% below its Initial Index Level. If on any quarterly observation date, the Index does close more than 40% below its initial level, no income payment will be made in respect of that period.

If things start looking positive, in that it looks less likely that future income payments will be missed, there’s a catch in that the plan will mature early, returning original capital and a final income payment if on any quarterly observation date, the FTSE 100 Index closes at least 5% above the Initial Index Level.

If the plan does not mature early and the Final Index Level is more than 40% below its Initial Index Level, no income payment will be made in respect of that quarter, additionally if such a fall does occur, investors will suffer a reduction to their invested capital equal to the percentage the Final Index Level is below its Initial Index Level.

An alternative to Option 1 is, not surprisingly, Option 2 which offers the potential for higher gross quarterly income payments of 1.75% (7% annually). Although the coupon is slightly higher there is a greater risk of interruption to the income stream offered. Income will be paid under Option 2 as long as the FTSE closes no more than 20% (rather than 40%) below its Initial Index Level on the quarterly observation dates. As with Option 1, if the FTSE is below the income threshold on any observation date, the income for that quarter will be lost, if it is 5% above, the plan will mature early and if it doesn’t do so, and the Final Index Level is more than 40% down capital will be lost in line with the fall. Therefore, if the FTSE is 25% down throughout the term and finishes 45% down on final observation date, Option 2 will provide no income and only return 55% of original capital.

The counterparty to the Meteor plan is Natixis which is the second largest banking group in France with 36 million clients spread over two retail banking networks. Natixis have long term credit ratings of, Fitch ‘A’, Moody’s ‘A2’ and Standard & Poor’s ‘A’. It should be appreciated however that if the bank fails, income will cease and there is a chance that all capital will be lost.

Although, both Options of this plan may appeal to some income seeking investors, we at Lowes made the decision not to ‘Prefer’* either option because we feel the income interruption risk is too great. We accept however that as part of a diversified portfolio where investors understand and accept the risk they might play a part for some investment managers.

As ever, it is important that investors read the investment literature thoroughly and if there are any doubts about the suitability of a particular investment or proposed course of action they should seek appropriate advice.
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