| Investment products: new options to consider |
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| Investors should consider structured investment products if they want to preserve capital whilst gaining exposure to market return potential, says Mark Caffrey. |
2008 has proven to be an incredibly challenging year for investors globally. At the time of writing, the Dow Jones Industrial Average is down 41 per cent year to date, the FTSE 100 by 42 per cent and the ISEQ by 66 per cent. Commodities have not fared much better with Brent Crude down 31 per cent, copper 49 per cent and aluminium 20 per cent. We have witnessed a month of banking collapses, government initiated rescue plans and mergers of some of the largest banking institutions in the world. The effects of the US housing slump and the credit crunch have well and truly found their way into global stock markets. And now, there is a very real concern that the problems besetting Wall Street will manifest themselves on “Main Street” as the spectre of recession raises its head globally. | | Mark Caffrey |
There is no doubt that investor confidence has been adversely affected by market conditions with capital preservation rather than enhancement being the strategy of choice. Whilst trying to call the bottom of the markets has about as much appeal as trying to catch a falling knife it is important to remember that investment has always been about having a view over the medium to long term. Business cycles have always been with us and we could do worse than remember Warren Buffet’s advice that “You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”
Structured investment products
One way for investors to preserve capital whilst also gaining exposure to market return potential is through capital protected structured investment products. The market for structured investment products in Ireland is estimated to be worth €3 billion. In terms of distribution retail tracker products account for 40 per cent of the market, CPPI (constant proportion portfolio insurance) structures 50 per cent with the balance accounted for by flow products, reverse convertibles and pure derivatives. The range of instruments included in the structured product universe makes it difficult to come up with a standardised definition for a structured investment product. At its simplest a structured investment product is a product combining derivatives and a fixed income component in the one instrument and with a fixed maturity. The derivative component is frequently an option. The option can be on a range of different underlying instruments including stock (either single stock or over indices), commodities, foreign exchange, property or funds for example. The fixed income component can be either a note or a deposit. The latter component provides periodic interest payments at a fixed rate, whilst the derivative delivers a variable return at maturity. Whilst an investor can conceivably gain such exposure through direct dealing, transaction size and cost considerations frequently put such investment strategies beyond the reach of the mass market. Another attraction of structured investment products is there is no requirement for investors to post margin.
These features make structured investment products an important product for consideration in any investment portfolio. They offer great flexibility and the ability to tailor an investment strategy and payoff to your own view. The range of underlyings now available also facilitates greater diversification benefits in investor portfolios that historically may have had a strong equity and property bias. Structured investment products can also deliver positive risk adjusted returns in good and bad market conditions. Interest in these products has been growing in recent years, both at high net worth level for portfolio diversification and asset allocation purposes and at the mass retail level.
The majority of products issued in the Irish market tend to be 100% capital protected at maturity, although there has been a trend in recent years among retail issuers to market “secure” and “growth” (less than 100 per cent protection) versions of the same product. Another trend has been to combine “growth” and “income” features in the one product, where for example a headline return is offered on a certain percentage of the invested funds after a defined time period with the remainder going into a tracker for a longer term.
The majority of products issued in Ireland are wrapped as a deposit (roughly 70 per cent). Other prominent wrappers are funds, pensions, life assurance and structured notes. Virtually all issuance is in the DIRT regime for tax purposes although there are products in issue that qualify for the CGT regime.
Ulster Bank Capital Markets offer access to a range of markets, including interest-rate, foreign exchange, fixed income, equity, commodity, property and hedge-funds or combinations of these markets in capital protected or capital at risk format, with or without other investment features such as income, leverage and many others.
We have responded to today’s turbulent conditions by adding liquidity features in addition to capital and income security features in our product stable. An example would be our Triumph Investment Bond which provides our clients with enhanced deposits and access to commodities, equities, infrastructure and bonds. Liquidity is delivered in the form of embedded short term cash deposits.
New product developments
“Theme based” investment is also a market demand we have responded to. With the publication of Ireland’s “National Climate Strategy” and the arrival of the Green Party in Government we found that customers were expressing increased interest in green products. We pioneered the development of green-related products in Northern Ireland through the Double Reward bond last year and in 2008 we were the first to offer a 100 per cent capital guaranteed green themed bond.
Our Green Global Bond tracks the RBS Green Index, an index of some of the most prominent companies active within the green business sector including hydroelectricity, solar, wind energy and waste management.
The Autopilot Investment Bond follows trends and price levels of four distinct market sectors; equities, emerging markets, property and commodities. Every month Autopilot observes the current market price relative to the average price of each market sector over the last 12 months (six months for emerging markets). If the current market prices are above the sector average of recent prices, Autopilot invests in the sector. If the current market price is below the sector average of recent prices, Autopilot will switch out of the sector and invest in cash. A key output of the Autopilot investment strategy is the monthly ‘Autopilot Index Level’. This is initially set at 100, and will post rises and falls each month depending on the performance of each of the sectors and the cash deposit rates.
The Autopilot Investment Bond also has a performance lock-in feature which provides customers with additional security throughout the investment term. Each time Autopilot performs by 10 per cent, 60 per cent of this growth is automatically locked in. This allows customers to safeguard their returns.
Looking forward to 2009 I believe the range of products and payoff types available in Ireland will continue to grow, notwithstanding our more challenging economic times. Investor focus will be sensitive to issuer credit quality, and demand will focus on intuitively easy to understand products. Demand for liquidity features within products is set to continue and in the longer term a secondary market for structured investor products will become increasingly important.
Following the “annus horribilis” for investor markets in 2008 quality of service and trust will be more important than ever. Investors will want to work with a valued partner with an established track record.
I am confident that the next twelve months will present as many opportunities as they do challenges. |
Mark Caffrey is head of structured investment products at Ulster Bank Capital Markets.
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