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The Proof is in the Pudding - 16/11/2022

Max Darer, Lowes Financial Management

It is somewhat unlikely that you have not heard of the FTSE 100 Index, compromised of the 100 largest companies listed on the London Stock Exchange and the most commonly utilised underlying for structured products in the UK retail sector. The FTSE 100 is a ‘price return’ index and it therefore does not reflect the dividends paid out by the companies. The anticipated dividend yield over the holding period will ultimately be of key importance (amongst other factors) when counterparties base their terms for new issue structured products.

Over the coronavirus pandemic dividend yield expectations sharply dropped, which, combined with uncertainty about COVID recovery, meant that banks erred on the side of caution by building in a greater margin to account for yield uncertainty when pricing FTSE 100 linked structured investments. What resulted were substantially lower coupons than pre-pandemic issues, and then a solution: the birth of the CSDI (FTSE Custom 100 Synthetic 3.5% Fixed Dividend Index).

Designed specifically for structured products, the CSDI tracks the same 100 shares, in the same proportions but unlike the FTSE 100, the CSDI includes the benefits of the dividends (which historically average 3.5% per annum), then deducts the equivalent to a fixed 3.5% dividend per annum, on a daily basis. The result is that the index will perform almost identically to the FTSE 100 if dividends are 3.5% p.a, moderately underperform if they are less, and moderately overperform if they are more. As of September 2022, the implied dividend yield of the FTSE 100 from 2022 is 4.3%. [1]

FTSE CSDI Historical Performance Since Launch vs FTSE 100

FTSE 100 data sourced from CSDI data sourced from Mariana.

The high correlation of the FTSE CSDI to the FTSE 100 offers investors exposure to the same market, in the same proportions.

Correlation of FTSE CSDI vs. FTSE 100 Index (as of 08/11/2022) [2]

5 Year 99.80%
10 Year 99.80%
20 Year 99.93%

To reiterate, the fundamental benefit of the CSDI as an underlying rather than the FTSE 100 is that, for the counterparty bank, taking a fixed 3.5% ‘dividend’ drawdown removes the guess work and forecasting errors for the potential dividend yield, allowing them to hedge more efficiently and at a lower cost. Therefore, despite being over 99% correlated to the FTSE 100, the pricing of structured products using the CSDI translates to a greater coupon than an otherwise equivalent FTSE 100 contract as a function of the end investor accepting the risk of dividend variability.

To provide an indication of the uplift from utilising the CSDI can bring, the table below highlights pricing for the 10:10 Plan December 2022 obtained from Citigroup by Mariana for both the CSDI and FTSE 100.

Mariana 10:10 Plan December 2022 Indicative Pricing (Citigroup) [2]

10:10 Option 1 9.75% 8.90%
10:10 Option 2 11.00% 10.20%
10:10 Option 3 12.25% 11.20%

Two years on from the striking of the first CSDI linked autocall – the Mariana 10:10 Plan November 2020 - all three options matured on the second anniversary on the 7th November 2022. The results are in line with the defined coupons offered at outset and as such, are better than those that would have been returned for equivalent FTSE 100 linked contracts:

Mariana 10:10 November 2020 Maturity Results

Total Return Annualised Return
Option 1 14.30% 6.91%
Option 2 18.00% 8.63%
Option 3 23.00% 10.91%%

Since the first CSDI linked issue of the 10:10 Plans, there have been 15 more issues, with the latest being the Mariana 10:10 Plan December 2022. Full details of all three Options can be found here, however the key features of Option 2 are as below.

[1] Link Group Dividend Monitor Issue 51 Q3 2022

[2] Mariana Structured Investments

Structured investments put capital at risk.

Past performance is not a guide to future performance.

Disclosure of interests: Lowes has provided input into the concept, development, promotion and distribution of the 10:10. Lowes has a commercial interest in these investments as a result of its involvement. Where Lowes is involved in advice on these investments to retail clients, it will not receive benefit of any fees for its involvement, other than those fees payable by the client to Lowes.

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