Choppy (volatile) investment markets; keep an eye on Structured Products
With investment markets (and currency markets) delivering ‘choppy’/increased investment volatility (and currency markets delivering a white-knuckle ride!), a recent article from David Stevenson (who supports our Newsletter) – click the links to read David’s input to our Newsletter:
David Stevenson’s views by Daniel Grote highlights David’s views and the general thinking/considerations during increased spikes in volatility …. see David’s article below or click on the following link: https://citywire.co.uk/funds-insider/news/david-stevenson-amid-choppy-markets-keep-an-eye-on-structured-products/a1272018
“David Stevenson: amid choppy markets, keep an eye on structured products
By Daniel Grote 24 Sep, 2019
One of the most common questions I get asked is what should investors do when market volatility spikes?
As luck would have it, we have been experiencing a fair dose of market volatility in the last few weeks. Will we go war with Iran? Will Trump dial down the dispute with China? Are we perched on the edge of a recession? My stab at answering all three is a hesitant ‘no’ but what do I know? As for the questions about what to do, my answer generally falls into three parts.
The first one is to ignore market volatility. If your time horizon for investing is many decades the ups and downs of the last few months shouldn’t really concern you.
For more opportunistic investors, use that market volatility and buy a bit more of what you like. Other people’s blind panic can be your buying opportunity.
But there is a last answer which accepts that some investors have shorter time horizons (maybe three to eight years) or no real contrarian conviction and are thus not willing to take the plunge and buy cheaper stocks.
This answer is also shaded by the recognition that markets do suffer from what are called regime changes. A rampant bull market which lasts for ages can turn into a sullen, depressed, volatile market that trades sideways for years. Spotting those changes is nigh on impossible but one can plan around them.
If this third answer is more appropriate to you as an investor, the immediate easy solution is to pick a fund which has an absolute return mandate, aiming to deliver positive returns in all market conditions.
But funds that pull off this strategy are rare and precious. I’ve already talked about the handful of absolute or target return funds that interest me in a previous column, so I won’t repeat that argument. All I would add is that you might not go far wrong with some investment trusts, such as Capital Gearing (CGT) or a more avowedly hedgie oriented fund such as BH Global (BHGG) and BH Macro (BHMG), both run by Brevan Howard. These kinds of funds either sit tight in less risky assets or make positive returns by speculating on big market moves based on careful macroeconomic research.
Structured products alternative
There is an alternative and again I’ve mentioned it before in these columns. Structured products. Many investors, rightly, groan and roll their eyes when I mention this option. They are right that in the past many of these investment products were horrendously structured, and terribly marketed. They can be black boxes that are difficult to understand. And they can hide huge charges that seem excessive when compared to a straightforward FTSE 100 or S&P 500 fund investment, which reaps all those increasingly juicy dividends.
But in the last decade the industry has smartened up its act, in part under pressure from the regulators, and in my view most products sold through independent financial advisers (the best channel for the better products) are now perfectly sensible products that should be researched on their individual merits, not cast aside as a dodgy investment category. Evidence for this comes from industry stats. A recent report crunched returns for the last 10 years, from January 2009 to December 2018, looking at all 3,670 structured products which matured.
In total 3,613 (98.5%) generated positive returns or repaid capital: with an average return of 6.2% a year. Only 57 (1.6%) maturing structured products delivered a loss for investors over the decade.
The average duration of all maturing structured products over the last 10 years was just 3.8 years, despite their maximum terms being longer at the outset.
Turning to the last three years, from 2016 to 2018, 927 structured products matured. The average annualised return of all products was 6.8%, with capital-at-risk products delivering 7.5%.
Crucially, not a single maturing structured product created a loss for investors. This is an exceptional statistic. For full disclosure, I write a regular market update for the industry association and have owned structured products in the past.
Back to my market volatility point. Why should investors be more interested in these products in turbulent times?
When market volatility shoots up, the pricing on structured products sometimes drastically improves. I’d even be tempted to say that for much of the time, it can pay to wait for a bout of market panic before buying a structured product. And as structured products tend to appeal to more cautious investors with time horizons of, say, five to eight years, waiting for the right time to buy can be hugely important.
To understand this important point, I asked one of the leading structured product providers to pull together examples of how pricing on structured products can change drastically. The driver behind this change in pricing isn’t difficult to understand. Built into nearly all structured products is a range of options including ‘call’ and ‘put’ options whose pricing changes rapidly if market volatility shoots up.
The provider I talked to is called Tempo Structured Products, a relatively newish provider which has been established by a team which helped create the US structured products sector in the mid-1990s.
Through IFAs, this provider offers a kick-out product called the Long Kick-Out Plan. Option 2 will generate 9.95% a year over the next decade even if the index has fallen by 5% per year to just 65% of its start level in a decade.
Potential returns for this product, which first opened in May and June, have increased significantly in September and October. The 9.95% return cited above would have been 7.4% in June, in other words 2.55% a year less, for the exact same product.
Similarly, Option 3 of the Long Kick-Out Plan is offering 4.95% a year more now than in June, while Option 2 of its Long Growth Accelerator Plan is offering an extra 65% at year five of the plan (equivalent to an additional 13% a year), than in June.
I would also mention one other key selling point. Once one scrubs away all the language and jargon surrounding structured products one comes to a simple calculation. Can you trust the counter party behind the structured product to make the eventual repayment to you?
That counterparty is usually a leading global investment bank. My own contention is that in the new financial order we live, built around low interest rates for longer, the central banks care hugely about the stability of the global important banks.
There’s a whole new financial reporting edifice of regulations designed to make sure these crucial liquidity institutions don’t fall over. On paper most of these systemically important banks are in hugely better shape with strong capital buffers and increasingly liquid capital stacks. In this scenario I think these are a decent bulwark in a market that is likely to be punctured by recurrent bouts of market volatility.
In return for taking their credit risk – the chance that they may go bust and you don’t get back your defined return from the structured product – you get an investment return by contract.
Structured products are contracts where you have a defined return if a number of conditions are met. If they are (the bank doesn’t go bust, the stock market doesn’t plunge 50%), you get your money back plus the defined upside. For many cautious investors that’s not a bad proposition and arguably a more attractive and less uncertain outcome than with many absolute return funds.
That said, these products won’t protect against a massive fall in the stock market (say 20% to 50%) which might trip a leading investment bank into a default situation. Nor will they beat a simple strategy of sitting tight in equities for a few decades, collecting and reinvesting that regular dividend cheque.
But if you do want to pick up keenly priced investments that could make a difference in a shorter time span, remember to check out structured product pricing during bouts of heightened market volatility.”
This article has become increasingly topical given last week’s failure of Reyker Securities – being placed into Special Administration – the Company was more than a Structured Product issuer … (we will be providing an update on the Reyker matter, but reassuringly we have not been providing advice to invest into Reyker products or listing Reyker/Augere Plans for some years – as we didn’t like what we saw/experienced – due to service response and clarity in relation to questions we posted not being answered by the issuer!)
The Reyker failure highlights the imperative nature of Due Diligence consideration for DIY investors – if not using Advisers!
Most non-advised services were listing and actively promoting Reyker Plans up until the news broke.
An update will follow in relation to this matter.
The focus of this communication is in relation to investment market volatility …
We are often asked the following questions:
- Are investment markets likely to suffer further if Global politics remain a mess? The simple answer is volatility is likely to remain, picking up as political differences increase and reducing at more settled times.
- What investments do well in bear markets? Defensive investments usually ‘do better’ when volatility increases – which are essential ‘personal assets’. Often, other asset classes – such as Bonds also produce a counterbalance – which is why an investment asset allocation spread is so essential.
What not to do when investment markets suffer……
“One thing to never do when the Stock Market goes down” – click on the link below to read more:
Structured Products generally provide a ‘Barrier’ of defence to an index falling, often suffering no capital loss until the relevant index falls by 20, 30 or sometimes as much as 40%.
David Stevenson highlights Tempo as an issuer …. We very much like what we see from Tempo – from Product Governance and transparency – through to market leading terms (although for some, requiring advice has been seen as a drawback but should be seen as a benefit!).
Reyker’s failure highlights the need for not only understanding the Investment Market Risk, Counterparty Risk but also Plan Manager Risk…….
At Best Price FS we make great decisions, this is another example of a great call, producing best outcomes for consumers ….
We will be asking all Plan Managers to provide us with an ‘update’ to our Due Diligence process of engagement, providing protection where we can.
We trust you see this process as beneficial.
Richard and the Best Price FS Team
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