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Benefits of 8 and 10 year terms for structured products

Longer investment terms increase the opportunity for structured products to mature with a positive gain for investors, says Colin Mclachlan, Lowes Financial Management

The majority of structured investments offer contingent capital protection, where capital is only lost at maturity if the underlying index falls by more than a specified amount, typically between 30-50% at the end of the maximum investment term.

If such a fall does occur, investors capital is usually reduced on a one for one basis, meaning that if the underlying index fell by 60% over the term, the investor would suffer a capital loss of 60%.

Such losses, however, are only determined at the final observation date if a positive maturity has not been triggered sooner.

With this in mind, at Lowes we have long favoured products with a longer maximum investment term, which by definition provides greater opportunities to mature with a gain, particularly if no market growth is required to trigger a positive maturity.

Two FTSE 100 linked investments currently available are the Mariana 10:10 Plan June 2018 and the Investec/Lowes 8:8 Plan 3*. Both offer contingent capital protection over extended maximum durations and both the 8:8 plan and Option 1 of the 10:10 Plan can produce positive returns in negative markets.

The chart below (click to enlarge) shows the early maturity Observation Levels and Capital Protection Barrier level of both plans, assuming a strike level of 7500. If the FTSE 100 closes above any of the Observation Levels the respective plan will mature with a gain. If the Index closes below every level it would have to also close below the Capital Protection Barrier for the respective plan to give rise to a loss from market movements.

Whether you have a positive, negative, or uncertain outlook on the British/global economy, these investments could be appropriate as part of a diversified portfolio.

The maximum, potential duration of both plans is longer than the typical six-year plan, not least because we here at Lowes Financial Management played a part in the conception of both investments, with a view to achieving better outcomes for our clients and other investors.* The maximum term was not increased to enhance the coupon available, but rather to enhance the possibility of the investments ultimately generating positive returns in adverse market conditions.

The Mariana 10:10 Plan June 2018 – Option 1

Option 1 of the latest 10:10 Plan offers a potential 7.14% for each year held, and can mature from the second anniversary onwards, provided that the FTSE 100 Index is above a specified reference level that reduces each year. The reference level on the second anniversary is 102.5% of the FTSE 100 level recorded on 28th June 2018 and this is reduced by 2.5% for each subsequent anniversary, reducing to 82.5% on the tenth.

If the plan runs the full ten-year term due to unfavourable market conditions and the FTSE 100 level on the tenth anniversary (28/06/2028) is at, or above 82.5% of the initial level, then the plan will mature returning original capital plus a gain of 71.4%. If on the other hand the market remains unfavourable and the final index level is below the 82.5% level then the plan will return capital only, unless the FTSE 100 Index is below 70% of the initial level, in which case capital will be reduced on a 1:1 basis. For example, if the FTSE 100 Index was 35% lower at the end of the ten years (having not been above any early maturity trigger levels throughout the term), then investors would suffer the equivalent 35% loss.

To put this into context, assuming the FTSE 100 index level recorded on 28 June is 7,500, the index would have to be below every early maturity reference level throughout the term and below 6187.5 in ten years’ time for the investment not to produce a gain, and below 5,250 to give rise to a loss from market movements.

It is important to note that the returns from all such investments, including the return of capital, are dependent upon the relevant counterparty remaining solvent and meeting their obligations. The counterparty for this issue of the 10:10 Plan is Natixis who have a Moody’s rating of ‘A2’

Investec/Lowes 8:8 Plan 3

Like the 10:10 Plan, the 8:8 Plan will mature early if simple, pre-defined conditions are met. However, rather than having a reducing, early maturity reference level like the 10:10 Plan, the maturity trigger for the 8:8 Plan is fixed throughout the term at 92% of the initial index level (recorded on 26/06/2018). The third issue of the 8:8 Plan offers a maximum eight-year term with a potential coupon of 7.5% per year (simple), and has the additional benefit of a potential maturity every six months, from the second anniversary onwards, rather than just annually. While the Mariana plan offers a longer term and therefore more chance for the FTSE 100 Index to recover if a severe fall were to occur, the Investec/Lowes plan (whilst still having an extended term) offers more kick out opportunities due to the semi-annual observations and so may capitalise on shorter term market fluctuations.

If the 8:8 Plan runs the full eight-year term due to unfavorable market conditions and the final level recorded (26/06/2026) is above 92%, the plan will mature returning original capital, plus a gain of 60%.

While the final potential observation date and, therefore, the capital protection barrier test, for the 8:8 Plan is two years sooner than for the 10:10 Plan, the barrier is set at 60% rather than 70%. To put this into context, again assuming the FTSE 100 index level recorded on 26 June 2018 is 7,500, the index would have to be below every early maturity reference level throughout the term, and below 4,500 in eight years’ time for the investment to give rise to a loss from market movements.

The counterparty on which the returns and return of capital for the 8:8 Plan are dependent is Investec Bank Plc, which also has a Moody’s rating of A2.

Back testing

Both plans put invested capital at risk. Historical back-testing of both the 8:8 and 10:10 (Option 1) strategies, looking at every day the FTSE 100 has been in existence, shows that neither strategy would have failed to mature with a gain, regardless of when it theoretically commenced. As we know, past performance is no guarantee of future performance, and so it is clear that the potential returns offered by these investments are a function of the acceptance of the potential default risk of relevant bank, coupled with the risk that future FTSE performance could be less favourable than in the past.

Obviously, these investments will not appeal to those targeting double digit, annual returns but are perhaps more suitable for more conservative elements of a balanced portfolio. For such portfolios you have to ask yourself, if these elements don’t ultimately produce positive returns, what aspects of a portfolio would?

Note:  Lowes provided input into the concept, development, promotion and distribution of these Plans. The provider’s charges/fees are built into the terms of the investment – Lowes has a commercial interest in the Plans as a result of its involvement in their development and promotion. All Plan returns are stated after allowing for the provider’s charges/fees. Where Lowes is involved in advice or on the intermediation of these investments to retail clients, it will not be paid any fee from Mariana or Investec for its input. The aim of developing Plans in co-operation with providers, with Lowes input, is that they should be amongst the best available in the market – and, as such, be granted ‘Preferred’ status, on their merits. Lowes has robust systems and controls in place to ensure that it manages any actual or potential conflicts of interests in its activities.


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