Structured products address “protection vs participation” dilemma facing investors

One of the key challenges for investment advisers in the current climate is to decide on positioning in what looks to be a mature global equity market. While the risk of a major correction or sell-off in the next two to three years needs to be taken into account, there’s also the “fear of missing out” on an extended bull market run.

Many advisers caution against trying to time the market, arguing that a long-term position in equities will outperform. Research shows that over the period 1900 to 2016, equities grew in real terms in US dollars (inclusive of dividends) by a factor of 300, compared with 8 for bonds and 2.7 for cash (source – Credit Suisse Global Investment Return Yearbook 2016). The equity growth number is despite taking the events like the Great Depression and Global Financial Crisis into account.

This is reasonable advice over the long term, but it does present challenges for investors who have a large investment maturing in the coming years or are approaching retirement. It’s prudent to take some sort of protection to mitigate the transition or the re-investment risks of a market fall. Switching to a balanced portfolio can help, but still leaves the investor exposed to overall market risk. On the other hand, cash can be an effective hedge, but only at the sacrifice of any market outperformance.

Structured products like Investec’s latest offering helps to overcome this “protection vs participation” dilemma. Britannic Opportunities, a 3.8-year investment, gives full capital protection, plus a minimum return of 3% in US dollars.

Japie Lubbe of Investec Structured Products says investors get meaningful participation if global equities rise over the investment period. Should the underlying basket of indices (40% S&P 500, 30% Eurostoxx 50, 30% Nikkei 225) rise by between 3% and 18.5% over the investment period (in US dollars), the investor will get two times that performance.

So, if the basket rises by 18.5% or more, the investor will earn a 34% return in US dollars, or the equivalent of 8% a year.

He says that Britannic Opportunities Limited is a compelling offering at a time when investors are worrying about “return of capital” rather than “return on capital”. He notes that while protection can also be attained by purchasing a put option, this is not cost effective for the average investor. “At current rates, the premium on a put option for the underlying indices will set you back about 16.5% of your initial investment – compared with the minimum 3% upside on this offering,” he points out.

“The 3% minimum return is also compelling when seen in the context of the potential downside. We ran an exercise to see what the worst 3.8-year performance was in each of the underlying indices, as well as the index basket – these ranged between -35% and -48%,” explains Lubbe.

Lubbe adds that the investment is US dollar-based, it provides an effective hedge against rand weakness. “So returns could be even higher in rand terms, should the rand depreciate.”

Although the economic exposure is in US dollars, investors can also invest in British pounds. The minimum investment is GBP 14 000 or USD18 000.

ENDS