Investment & Insurance Blog

Currently browsing Latest Posts

Financial Components of Structured Plans

Financial Components of Structured Plans ….

The second half of 2022 will go down in history for the time when GBP interest rates finally increased, and more importantly how fast and strong that rise was. After 14 years of exceptionally low rates post the 2008 financial crash and then the European Sovereign credit crisis, it came as a surprise to many.

Structured plans are made up of two financial components, a zero-coupon bond (ZCB) or similar and a derivative to provide exposure to an underlying financial market, such as the FTSE 100. The ZCB is a non-coupon paying bond and as such, is bought at a discount to par (100%). The difference between that discount and par is used to invest in the derivative.

The important point here is the magnitude of that discount is affected by interest rates, as bonds have an inverse relationship with rates. When rates are higher, the ZCB discount is lower (and vice versa), and hence the amount to “spend” on the derivative either increases or decreases with interest rates. From the above, it is clear to see that with higher rates, the ZCB is discounted further and more of the derivative can be purchased to improve the terms of the structured plan. Therefore, during the last 14 years with rates so low, the upside terms have been challenging.

The UK structured market space had to adapt to this low interest rate environment – manufacturers and distributors alike began to launch products with “soft” capital protection to help with headline yields. So, what is “soft” protection?

Soft protection allowed investors to cope with a drawdown in markets, a cushion if you like, mitigating risk on the downside until a predetermined limit, or barrier. This is typically achieved by selling an at-the-money put with a “knock in” barrier, say at 65% or 60% of initial start level. The “put” is only activated if this barrier level is breached and therefore if it isn’t, the put expires with no value and the investors’ capital into the structured plan is 100% protected.

For selling this put, or risk, manufacturers can use the premium provided by selling options, to buy options to gain exposure to a market, providing the payoff in the structured plan.

Until very recently, almost 100% of structured plans exhibited this soft protection. However, in the last few months, with interest rates so much higher the “value” for soft protection has become a far less important factor as the discount of the ZCB has increased drastically. Looking at some numbers:

Financial Components of Structured Plans

June 2020:

· 5-year interest rates at 0.60%

· ZCB therefore at discount to par – circa 97% (therefore only 3% to spend on a derivative) * · Premium for selling an ATM put in the FTSE – circa 9% (3 times the value of the ZCB discount) *

· Total spend on the derivative – 12% October 2022:

October 2022:

· 5-year interest rates at 5.00%

· ZCB therefore at discount to par – circa 78% (therefore 22% to spend on a derivative) ·Premium for selling an ATM put in the FTSE – circa 9% (just 0.4 the value of the ZCB discount)

· Total spend on the derivative – 31%

From these simple calculations the “value” of the risky element to structured plans gives far less to the overall “spend” on the upside of structured plans. In-fact, given that it is so much less, why implement it at all?

IDAD have looked at this change in value and transitioned their structured plans to 100% capital protected plans currently, without any downside risk if held to maturity. We believe that they offer the best risk reward for investors – see below for the current IDAD plan offering.

Barclays – UK and Europe Deposit Kick Out Plan – Issue 3

Deposit Taker: Barclays Bank plc
Investment Term: 6 year 2 weeks
Kick Out Trigger Level: 100% of Initial level (from year 4 onwards)
Coupon Rate: 8.00% per annum
100% Capital protection

Click here for more details of the above plan.

Morgan Stanley – Capital Protected UK & Europe Defensive Kick Out Plan

Issuer: Morgan Stanley & Co International Plc Investment
Term: Up to 6 years. Potential to mature early from the first observation date at year 4 then annually thereafter
Kick Out Trigger Level: 100% of Initial Index Levels at the first kick out observation date reducing to 95% & 90% thereafter
Coupon Rate: 9.45% per annum
100% Capital protection

Click here for more details of the above plan

*Source: Bloomberg 27/11/2022

Don’t Forget the Risks

As with all forms of investment there are risks involved. Some plans do not guarantee to repay the money invested. The potential returns of the plans and repaying the money invested are linked to the level of the stock market and also depend on the financial stability of the Issuer and Counterparty Bank.  It is essential that investors read and understand the risks of the plan(s) which are clarified in the product documentation.

Past performance is not a guide to future performance and may not be repeated.  Investment involves risk. The performance data does not take account of the commissions and costs incurred on the issue and redemption of shares. The value of investments and the income from them may go down as well as up and investors may not get back any of the amount originally invested.  Because of this, an investor is not certain to make a profit on an investment and may lose money.  Exchange rate changes may cause the value of overseas investments to rise or fall.

The promotion of the plans does not constitute ‘advice’ to invest. Advice is always specific to an individual investor’s circumstances and needs, following the process of ‘know your customer’, with the aim of ensuring that any product is suitable for an investor.

As always, the recommendation and common sense approach is to consider product solutions as a portfolio, never over-exposing oneself to a point of financial pain and suffering liquid or counterparty exposure.

At the Best Price FS price point the IDAD Plans are certainly worthy of consideration for inclusion within investment portfolios.

Warmest Regards.

Best Price FS Team

Advice: Simply click here to get in touch if you wish to receive regulated advice in relation to the ‘suitability’ of the plans to meet your investment needs.