It seems like even before Covid global markets were becoming less predictable and swings on the value of many asset classes even larger. No-one has missed the crash of cryptocurrency exchange FTX and dramatic news stories like these aren’t hard to find or limited to immature markets and emerging asset classes. So, where can investors seeking a more defined return turn?
Structured products revisited
An increasing number of investors are turning to structured products as a core part of a diversified portfolio. Their flexibility and modular nature creates an investment that has both the characteristics of stocks and bonds. With predefined coupons and capital protection barriers, they are also especially well-suited to protecting portfolios during extreme downturns in the market.
At Hilbert Investment Solutions, we are confident that structured products will continue to provide an element of downside protection during times of high market volatility. Throughout the turbulent events that accompanied the COVID 19 pandemic, we found that Hilbert clients continued to see positive returns without any loss to their initial capital. In fact, many of our structured products saw double digit returns.
In their simplest form they are an investment product, usually issued by a bank, with the returns being linked to predefined criteria’s such as the performance of a specific index or selection of stocks.
So, what are structured products?
To break this down further lets first look at the counterparty banks’ role. When a bank issues a structured product, it is in effect receiving a loan from the investor.
Now, with a traditional loan, usually the borrower and the lender agree a date to pay back the loan with a pre-defined level of interest.
However, with a structured product the borrower i.e. the bank, additionally says to the lender i.e. the investor. “I can pay you an enhanced level of return if you are willing to accept some market risk on the money being lent?”.
The Investor can then express the level of risk they are willing to accept, their specific requirements regarding the frequency of the interest, their individual tax circumstances and so on.
It would be at this juncture where Hilbert’s expertise come in. As a plan manger, we sit between the bank and the investor and structure the terms of the final product based on a particular target market. For example, our Income product is linked to the performance of the FTSE 100 Equally Weighted 45 Point Decrement Index and offers a potential income payment of 2% per quarter, if the closing level of the index hasn’t fallen more than 20% on any of the quarterly measurement dates.
If the index is below 20% then the bank simply doesn’t have to pay the coupon for that particular quarter. However, Hilbert have designed the product to incorporate a memory feature meaning that on the following quarter should the index be above the 80% threshold (the 20% fall) then the investor receives their 2% coupon for not only that current quarter but also for any quarters that had previously missed coupons.
Why the level of capital protection is key
Not all capital protection is created equal, so this also needs to be considered carefully as these are the terms according to which the investor will receive their initial capital back from the bank.
If, as an example, we use a product with a 10 year term the product terms may state that on the final day of the 10 year investment term, if the index has fallen more than 40% since the start date of the product, the initial capital will be reduced by the same percentage amount that the underlying asset has fallen in value, from the start date.
This is the worst case as it means that if an investor placed £10,000 into the Plan and the Underlying Asset had fallen by 41%, the repayment of their investment would be reduced by 41%, to £5,900.
The structured product spectrum
It’s important to note that not all structured products are created equal. You may have two products that have almost identical terms, with one paying a higher rate than the other. One reason for this could be down to the strength of the issuing bank. A bank with a lower credit rating may offer a higher coupon than a bank with a higher credit rating due to the perceived risk of lending that lower rated bank money. This is one of the elements that needs to be considered when assessing “counterparty risk”.
Also, barrier levels are a big part of choosing a product that fits within an investor’s view of the market.
If the investor has a view that the FTSE 100 will perform poorly, they may want to a select a product that pays a defined return even if the Index falls. Their view on the severity of this drop will help them determine what Index level they want the return to be triggered at.
A very cautious investor might want to receive a return even if the FTSE drops 35%. A less cautious investor may feel that they want their return to be generated if the Index only falls by 20%. Obviously, risk /reward return comes into play and the very cautious investor will receive a lesser return than the latter.
How structured products have weathered the storm
Time and time again over the years, and more recently during multiple lockdowns, the protective barriers at the heart of structured products have played their role with many clients investing across the sector being shielded from downturns in the market, while simultaneously making positive returns.
As such, in turbulent markets, structured products can be a perfect solution for optimising the risk/return ratio.
Achieving success in Structured Products
If you’re investing directly, or involved in providing financial advice, structured products deserve consideration – especially when market conditions are or are likely to become turbulent.
Exploring the following aspects with providers should help identify the right structured product for better investing;
- Consider plan managers with range of products designed to meet different risk appetites
- Understand all aspects of the structured product as elements such as memory features are not always included
- Look closely at the capital protection offered to understand its implications at the plan maturity date
- Pay close attention to the credit ratings of the issuing bank alongside the rates of return they offer
- Find an experienced plan manager with a proven track record delivering positive returns to policyholders during turbulent market conditions
If you’d like to find out more about the Hilbert Investment Solutions team that has been specialising in structured solutions for private clients and institutions since 2003, please email contact@hilbert-is.com.
More information about our current products and services is available at www.Hilbert-is.com ) or you can reach us at +44 20 3808 7138.
