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With more market uncertainty around now than most of us can care to remember, Sue Whitbread talks to Colin Brockman of Investec Structured Products to discuss the role of structured products as part of the core element of a client’s portfolio.
Q: Investec are well known as providers of structured products. Can you talk us through your experience in the sector?
A: Investec started offering structured products back in 2008 so we have plenty of experience. Back then about half the available structured products were deposit type plans and the other half were capital at risk plans. We’ve stuck with our process by offering a range of plans, which are open for subscription over six week periods. So advisers know that when one plan ends, another one starts again. Our current range of plans opens on November 7th 2016 and will run for six weeks. This gives certainty to the adviser as to what is available and when. Depending on consumer demand we will build our range of different products to suit different risk profiles, as well as the different planning needs for income or growth investing.
The market affects which products are more popular at any one time, but the fact that we have a complete suite, which is continuously available, supports the advice process. These products have been going on for a long time now and we often see rollover of capital at maturity, as once clients have had exposure to structured products as part of the foundation of their portfolio it gives them confidence that they can maintain that exposure going forward.
Q: What are the main types of structured products that Investec provide?
A: We have four or five different types of plans which are broadly segregated into 14 different individual products at present. Within those options, for example some are Investec backed, others are collateralised and others gilt backed.
The 14 plans are largely either structured deposit or structured capital at risk products. In each of those we have income or growth plans and also a hybrid. We have further segregated a couple into our retirement plan suite, which have been specifically highlighted to appeal to those clients at or near retirement. There’s been a big impact in the retirement space as a result of pension freedoms legislation and therefore these products works well in this space.
One product which has been aimed specifically at the retirement market is our retirement deposit plan. It provides a serious alternative to using fixed term annuities, these annuities will deliver a fixed income over a set term. If we take an example of a 60 year old male, they’d be looking at an income from a fixed term annuity of approximately 4-4.5% per annum, plus they would provide a guaranteed minimum capital return, typically around 85% of the initial investment for a six year term. If we compare that to our retirement deposit plan, firstly we can deliver a pretty comparable income yield of 3.75% per annum over the six years. However, if the FTSE 100 index at maturity (all our plans use this index as their base) is greater than 90% of its starting level then there is a bonus. The client will receive 100% return of capital – plus they will have received the income as well. There is not the same potential for loss as there is with the annuity route. We have to look at the potential downside too, should the FTSE 100 level at maturity be lower than 90% of the starting value, then clients would get their capital back less the amount of income they received over the term. This way, they have a decent chance of getting a return of their capital which they don’t have from a fixed term annuity, plus a level of income which is comparable.
This entry level product is aimed at clients in their retirement years who are looking for income. It is interesting that whilst advisers are often worried about counterparty risk, our research shows that consumers main worries are about the risk to capital. This product is firmly designed in line with this to give them that peace of mind.
Q: So what about those who are prepared to accept additional risk for the prospect of greater returns?
A: In those cases you could argue that our FTSE100 Enhanced Income Plan is better on both counts, although because there is counterparty risk which can translate as effectively being greater credit risk, clients must accept a risk to capital. This is what’s called a “non-contingent income plan”. It’s the only one in the market right now paying 5% income per annum, which is paid regardless of what the index is doing. The income is therefore not contingent but the capital is. The capital protection barrier is set at 50%. Clients will get a fixed and predefined income for 6 years, and return of capital as long as the index has not fallen by more than 50% at any point during the term (this switches off the protection), the index doesn’t need to get back to the starting value in order to deliver 100% return of capital. If the index does breach the 50% fall level then the capital returned will simply reflect the actual fall in the index over the term, making it broadly the same as capital exposed in a traditional collective investment scheme.
For clients prepared to put both at risk, our FTSE100 Defined Income Plan delivers a contingent income of 6% per annum. Again the “at risk” barrier comes in at 50% of the FTSE 100 starting level. But this time if the index falls below the 75% level then the income stream is halted. That’s the risk. However, if the index rises back above the 75% level then not only does the income stream return but all missed income payments are also paid.
Overall, we do have a very attractive range of products – almost no brainers. They can deliver a high income with a high probability of capital returns, and that’s on the income products.
Q What about backtesting? We know that past performance is no guide of course, but how do the products stack up if you look at how they would have performed historically?
A: We backtest all our plans very thoroughly, looking at all possible six year periods throughout history – broadly there are around 6,600 or so of those periods. In the case of our FTSE 100 Defined Income Plan for example, over 99% of historic time periods the income would have been payable in full at 6%. That’s a very high probability.
Stochastically looking forward to capital return, the figures are very similar. For the capital aspect, the likelihood of capital breached by 50% again is 99%. Although based on past performance, it does indicate a high probability of capital return and the level of income achieved, particularly when compared to what’s in the market from drawdown, or annuities etc. All those products are seeing squeezes on their income and some are removing guarantees too, as was the case with AXA recently.
We’re seeing a reduction in the forecasts for long term asset class growth assumptions Recently the Dynamic Planner forecasts for example have come down. Earlier this year they were forecasting long term return from UK equities at 7.4% per annum. It’s now been cut to 6.9% per annum going forward. This has many implications for all sorts of strategies including structured products, as it affects the cost of guarantees. We’re also seeing the risk free rate falling so there are wider implications for investors seeking a return on their capital. In the UK, it’s twice as challenging for those clients in retirement, as the impact of Brexit on sterling is already showing that inflation is likely to pick up into 2017, as the rising cost of imports takes effect. With income under pressure especially from savings, and the cost of living rising, the disparity is even worse.
Q: Is the current political/economic/market uncertainty having an impact on demand for structured products?
A: We’re seeing a steady demand, that’s for sure. There’s a perception at the moment that when the stock market is high structured products are not the thing to buy, and this is a view we sometimes find with advisers as well as end-clients. This surprises me as it’s rather counterintuitive. At our last consumer group meeting at the end of the summer, our participants told us that they were reluctant to look at defensive products at the current time with the market being so high. I would argue that at such times structured products make particularly good sense.
Q: Is there one of your plans that is particularly suited to uncertain market conditions?
A: We have the most risk averse product in the market right now – our FTSE100 Defensive Growth Plan. With a 6 year term, as long as the FTSE 100 index is at more than half of its starting value at the end of the term, then the investor will get their capital back plus a payment of 34%. It doesn’t matter if the index drops below that during the 6 years. For instances, taking the FTSE 100 at around 7000 today, if by 2022 it is above 3500 then this offers an attractive proposition, particularly when we are facing so many uncertainties.
Q:What about the thorny issue of credit risk? Is counterparty risk still high on advisers’ checklists these days?
A: Yes, counterparty risk can still be an objection for some advisers to buying a structured product. These risks have not gone away but they are much lower now than they were a few years ago. That’s particularly important for advisers and their compliance departments.
When it comes to risks, at Investec we have particular benefits. We are one of only a few banks to have credit upgrades over the last 18 months. We are now rated A2 with Moody’s, which is principally due to the cautious manner the bank is, and always has been run.
We also have a collateralised version of some plans which moves the credit risk from Investec onto the shoulders of 5 other A rated institutions, as well as a government gilt collateralised product too. So if counterparty risk from Investec is unpalatable, you have the option of other collaterised versions. We also have structured deposits covered by the Financial Services Compensation Scheme. Of course, the capital at risk products are not FSCS covered, and never have been. Credit risk is more important but can have government backed cover which currently has an AA+ rating.
Interestingly, with forthcoming MIFID and PRIIPS regulation being delayed, this raised questions about what it will mean in adviser assessment of counterparty risk. For the first time this legislation will allow comparison on a level playing field of different investment products via a key investor document, and risks will be shown on the SRRI scale from 1-7. For structured products in particular, this will mean that one number will reflect both the credit risk and the market risk of the product. This is very important. In theory, advisers could compare a single premium bond at say 4/7 with a multi-asset fund also say at 4/7 and then a structured product at 4/7 too. They will see all three comparable on a risk basis. We’ve never had that before due to unquantifiable counterparty/credit risk. We believe that this will put structured products firmly on the map, especially for advisers who are wary of the credit risk aspects.
Legislation was due out later this year but it looks like it will be delayed for 6-12 months. However, we can still calculate our SSRI scores with our deposit and income plans coming out at 3/7 and our capital protected at 4/7. Although perhaps unnerving, this is where many clients will see themselves on a typical risk scale – somewhere in the middle.
Q: What are the main types of structured product that advisers are asking you for and using at the moment?
A: Currently our defensive and income plans are most popular with advisers. With the strong stock market we’ve seen recently, appetite for risk increases and interest wanes a bit in getting underlying protection. In a falling market however, interest in our enhanced kick-out plan is notable. Now, our biggest selling products are the defensive kick-out products. One of these allows the market to fall by 10% and another by 20% (eventually but in steps). There is a lot of money going into these, but if the stock market were to weaken it would probably fall. With all the uncertainty that we now face, the prospect of negative interest rates in the UK, plus global uncertainty with elections coming up, I expect to see the use of structured products rise into 2017, as advisers look to build a solid base to their clients’ portfolios.
These are the views of the author, not Investec, and should not be taken as advice. To find out more, visit www.Investecstruturedproducts.com/adviser or call 020 7596 9216.
Colin Brockman is Head of Intermediary Sales for Investec Structured Products, part of Investec Corporate & Institutional Banking. He has been with Investec for 7 years and previously worked at Prudential in their investment development intermediary sales team, having also had roles in regional and national account management. Prior to this, Colin was one of the top IFAs within the South East region for a large national brokerage. He has worked within the specialist offshore tax and investment arena for a boutique IFA firm and has even spent time as a Constable for the Essex Police.
