Of course, it must be appreciated that this is not a recommendation to invest as the products may not be suitable for you. If in doubt, check with a suitably knowledgeable chartered financial planner. You can also read What Investment’s guide to structured products which gives an explanation of some of the terms used.
We could start building our structured product portfolio with the Societe Generale UK Growth Plan Issue 1. This already benefits from a degree of counterparty diversification in that the ultimate default risk is spread between Aviva, Barclays Bank, Lloyds Bank and Royal Bank of Scotland.
The investment itself has a six-year term, at the end of which, if the FTSE 100 index has risen by more than 6 per cent, the investment will produce its maximum gain, which is 60 per cent. If the FTSE has risen over the six years, but by less than 6 per cent, the product will pay ten times that rise. If the FTSE has fallen it will simply return the invested capital, unless it has fallen by more than 40 per cent, in which case it will track the fall in the index.
Whilst the Societe Generale investment is an attractive proposition in its own right, potential returns could be enhanced by blending it together with the Morgan Stanley FTSE Defensive Supertracker Plan 4.
This is also a six-year investment, which will produce a gain even if the index has fallen by up to 10 per cent, and will not give rise to a loss at maturity from market movements unless the FTSE 100 has lost half its value.
In the event that the FTSE has risen 10 per cent or more at the end of the six years, the investment will mature with a 62 per cent gain. If the FTSE finishes between 10 per cent down and 10 per cent up, the investment will return a gain of 3.1 times any rise in the index above 90 per cent of its initial level.
Let’s say our portfolio was weighted at 30 per cent into the Morgan Stanley plan and 70 per cent into the Societe Generale product. The credit exposure would then be split between five institutions: Morgan Stanley, Aviva, Barclays Bank, Lloyds Bank and Royal Bank of Scotland.
Sadly, the days are gone when the collapse of one of these names would have been regarded as an absolute impossibility. It is still extremely unlikely that one of them will fail, but should this happen, it is good to know that the loss would not be catastrophic.
Now for the returns. The maximum return this combination of investments could produce at the end of six years is a little over 60 per cent, so it will underperform other market-linked investments in a significant stock market bull run. However, in such circumstances, the portfolio will deliver its maximum return, which will not disappoint and will undoubtedly be more than virtually risk-free investments, such as cash deposits.
If, on the other hand, the stock market performs poorly over the term, the portfolio will produce returns which are likely to outstrip those achieved by tracker fund over the same period in all but the most extreme circumstances – such as one of the counterparty institutions failing or the FTSE losing more than 40 per cent over the six-year term.
In most other circumstances, the structured product portfolio will outperform a tracker, as can be seen from the chart below, which compares the contracted returns at the end of six years to those of a proxy FTSE 100 tracker. In estimating the tracker returns we have accounted for index movement plus 2.5 per cent per annum to account for dividends, less charges.
The chart indicates a narrow band of potential underperformance if the FTSE 100 index falls by up to 15 per cent over the term. This is the result of the dividends achieved from the tracker’s underlying components. Adding a product such as the Investec FTSE 100 Enhanced Kick-Out Plan 46 into the mix could help overcome this by producing gains in a broadly flat market during the six years, whilst at the same time, further diversifying counterparty exposure.
A possible criticism of our structured product portfolio is that all the products are linked to the performance of the FTSE 100. Investors seeking to take diversification a stage further could look at including exposure to the EURO STOXX 50 index too.
This could be achieved by adding the Meteor EURO STOXX Supertracker Plan July 2014, which is similar to the Societe Generale plan, except the gain is calculated as ten times the rise in the (EURO STOXX 50) index, capped at 70 per cent (rather than 60 per cent).
The downside risk is the same in that the index needs to have lost more than 40 per cent of its value at the end of the six years before losses from market movements will arise. The use of this product would further diversify counterparty exposure by adding Credit Suisse to the mix.
A further complement to this blend of products would be the Walker Crips Dual Index Plan (FTSE & EURO STOXX) Issue 3 – a product that will mature on the first anniversary that the FTSE 100 and EURO STOXX 50 Indices are higher than at commencement of the investment.
This plan will produce a gain of 12 per cent for each year it has been in force, and will not produce a loss unless both indices are below their initial levels on every anniversary and one or both are more than 40 per cent down at the end of the six years. The counterparty is Santander UK.
Whilst such a portfolio will provide clearly defined returns based on market movements, it could be diversified further by blending in a mini-portfolio of open-ended equity funds providing exposure to the UK and Europe. Whilst these equity funds will not provide the same certainty of returns in various market conditions, they will enhance the potential of greater gains in the event of a significant bull run.
It should be clear that all structured products are not created equal. In our opinion regularly comparing what the sector has to offer will help identify combinations of products that will dovetail with an investment portfolio, potentially enhancing portfolio returns whilst protecting against all but the most extreme events.