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Straight A's for 10:10

comparestructuredproducts.com - 03/08/2016

Diversification is an investment principle that has been highlighted in its importance by the recent market volatility. The expectation is that a well-diversified portfolio, on average, will benefit from more consistent returns and reduce the risk, in comparison to an individual product or investment.

Structured products can use a collaterisation and credit transfer programme to reduce the risk of catastrophic loss from counterparty failure. Since its first issue in 2015, the Mariana 10:10 plan has evolved to meet the diversification needs of investors. Currently on its 8th tranche, the collateralised structured product adds diversification benefits by spreading credit exposure across a predefined range of financial institutions. This process results in a proportion of the original investment being exposed to each named financial institution. Consequently, this reduces the risk of all your capital being affected in the event of a single counterparty defaulting.

The latest issue of the 10:10 plan has the credit risk transferred to Lloyds Bank Plc, Macquarie Bank Ltd, Santander UK Plc and Standard Chartered Bank, all of which are rated A by Standard & Poor’s. A quarter of the investment is exposed to each institution, and should any of the four financial institutions be unable to meet their wider financial obligations, that proportion of the investment could suffer a loss. The primary counterparty behind the plan is Societe Generale, also rated ‘A’ by Standard & Poor’s, but in the event of Societe Generale's failure the plan will be wound up realising the collateralised value of the assets. Whilst this is not likely to lead to the same level of potential catastrophic loss that would result from the failure of a sole counterparty, the winding up of the plan is still likely to result in less than the original investment value being returned.

Credit ratings give an indication of the strength of the counterparty and although there is debate over the worthiness of credit ratings following the financial crisis, they are still the benchmark used to assess an institution’s creditworthiness. Standard & Poor’s long term credit ratings range from ‘D’ to ‘AAA’ where, for example, ‘CC’ indicates that the financial institution is currently highly vulnerable in terms of its financial commitments, and ‘AAA’ denotes that the financial institution has ‘extremely strong capacity to meet its financial commitments’. These ratings may be modified by the addition of a ‘+’ or ‘-’ sign to show relative standing within the major rating categories.

Rated 'A' by Standard & Poor’s means an institution is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than higher-rated categories but capacity to meet financial commitments is still strong.

To get more information about particular counterparties’ credit ratings, please click here to access the counterparty research on StructuredProductReview.com.

The 10:10 plan options

The flexibility of structured products means that a number of options can be offered that could be chosen reflecting your market view, but all the options of the latest issue of the Mariana Capital 10:10 Plan are collaterised, with the credit risk spread across the four named banks. Lowes Financial Management were involved in the conception and development of this plan in collaboration with plan manager Mariana Capital.

The defensive option of this Plan, Option 1, offers the potential for a 7.1% gain on the invested capital for each year held, payable on any anniversary from year three onwards, provided the FTSE 100 Index closes at or above 90% of its start level with a maximum duration of ten years. The multiple opportunities for maturity and the extended investment term increases the likelihood of positive returns to be delivered and even in slightly depressed market conditions, the Plan can deliver these returns whilst reducing the risk of capital suffering a loss through the capital protection barriers used in the structured product.

In an environment of little or no market growth, Option 2 of the 10:10 Plan offers the potential for a 9.4% gain on the invested capital for each year held, payable on any annual anniversary from year three onwards, provided the FTSE 100 Index closes at or above its start level with a maximum duration of ten years.

For those more optimistic about the market direction, Option 3 of the 10:10 Plan offers a potential return of 12% on the invested capital for each year held, payable on any anniversary from year three onwards, provided the FTSE 100 Index closes 10% or more above its start level, again with a maximum 10-year investment term.

If the Plan fails to mature within the 10-year investment term because the FTSE 100 was below the required trigger levels and on the final observation date and the final index level is still below the required level, no gain will be achieved. However, investors' capital should still be returned in full, unless the final index level is more than 30% below the start level. That means the FTSE 100 will need to be depressed throughout the term and fall over 30% over the ten-year term for original investment capital to be lost from market movements. If such a fall does occur, the invested capital will be reduced by 1% for every 1% the final index level is below the start level. For example, if the plan fails to mature early and the final index level is 35% below the start level, investors will suffer a 35% reduction to their invested capital.

Alongside the ratings bestowed by the credit ratings agencies, learning about the profile of each financial institution backing a structured product can be useful when you’re assessing the risk of a particular plan. Below is some background on the different institutions to which the 10:10 Plan is exposed:

Lloyds Bank Plc

Commonly categorised as one of the ‘big four’ institutional banks, British bank Lloyds offers a range of comprehensive banking and financial services. The company provides retail banking, mortgages, pensions, asset management, insurance services, corporate banking and treasury services. The company has approximately 75,000 employees and over 2,000 branches throughout the UK.

Standard & Poor’s rating: A

Macquarie Bank Ltd

Macquarie Bank, founded in Australia in 1969, operates in 28 countries and employs more than 14,000 people. The company offers financial advice, wealth management, private banking, life insurance, securities brokerage, corporate debt financing, investment funds management and foreign exchange services.

Standard & Poor’s rating: A

Santander UK Plc

British institution Santander UK Plc operates as a full service commercial bank and reaches over 4.8 million customers. The bank provides personal savings and mortgages, secured and unsecured lending, banking, pensions and investments, life and general insurance, and written wealth management services.

Standard & Poor’s rating: A

Standard Chartered Bank

Standard Chartered Bank is a British multi-national banking and financial services company offering products and services in the personal, consumer, corporate, institutional and treasury areas. Originally formed in South Africa, the company operates a network of over 1,200 branches in 71 countries and employs roughly 84,000 people. The company is headquartered in London, but operates primarily in Asia, Africa and the Middle East.

Standard & Poor’s rating: A

Societe Generale

Societe Generale is one of the largest financial services groups in Europe and has been serving the needs of its clients in the UK for more than 100 years through a range of businesses: corporate and investment banking to private banking, asset management, and securities services, as well as specialised financial services including vehicle and equipment finance.

Standard & Poor’s rating: A

Disclosure of Interests: Lowes has provided input into the concept, development, promotion and distribution of this Plan. The provider’s charges/fees are built into the terms of the investment - Lowes has a commercial interest in the Plan as a result of its involvement in its development and promotion. All Plan returns are stated after allowing for the provider’s charges/fees. Where Lowes is involved in advice on or the intermediation of this investment to retail clients, it will not be paid any fee from Mariana for its input. The aim of developing Plans in co-operation with providers, with Lowes input, is that they should be amongst the best available in the market – and, as such, be granted ‘Preferred’ status, on their merits. Lowes has robust systems and controls in place to ensure that it manages any actual or potential conflicts of interests in its activities.