Ian Lowes from Lowes Financial Management says it is time for a mind-shift on structured investments.
"You can think about something in one way for a long time and it seems like the only way to think about it, but it really isn't. Somebody could make a suggestion that really sounds naïve. It might even be naïve, but it could have an important element of the truth in it. And it could be truth that one's overlooking." Edward Witten
It is time for a mind-shift on structured investments. With a handful of exceptions, very few structured products mature at a loss. That is not to say that the rest are all good, but I think those who have not yet been convinced of their potential benefits should look again and reconsider the opportunities that they are missing and from which many of their clients could be benefiting.
To say that recent years have been a turbulent time for investment markets would be a bit of an understatement. Therefore, it is not surprising that many structured products are simply returning the original capital. However, in the main, these are the investments that were designed to do just that in negative markets. The investments that exposed the capital to more risk are reaping arguably disproportional benefit for that risk premium, with many producing returns far in excess of the FTSE or the Cautious Managed Sector Average.
Looking at our clients' maturities last month, they tell a similar story to the month before that, with many enjoying returns far in excess of the market and with gains subject to the more favourable Capital Gains Tax. For example, we had a significant number of clients in a Woolwich Accelerated Growth Plan that matured last month after six years, returning a gain of 70%. That isn't a bad result given that over the same investment period the FTSE 100 rose by 21.5% and the Cautious Managed Sector Average rose by less than 30%.
This is far from a one-off; the Premier UK Growth Plan 28 matured after 5 years producing a gain of 37.5% against the Cautious Managed Sector Average rise of 17.5% and the Meteor Prima Growth Plan 18 has just matured on its first anniversary producing the targeted 8% return. While this is slightly less than the Cautious Managed Sector Average, it should be noted that with Meteor's product, investors knew exactly what returns they could receive from the start of the investment - unlike with a mutual fund.
Now obviously there were risks associated, but in order for these plans to have given rise to a loss it would have required either the FTSE 100 to fall to levels not seen since the early 1990's or Barclays or Rabobank to default. As such, I don't think we did too badly in suggesting them to our clients, who are very glad that we did.
This month we have a similar story and have some commodities linked plans maturing after five years, producing gains of around 80% - not bad considering that, in order to lose 10% or more of the original investment, it would again have needed a major bank to go bust or all commodities to be worthless!
Obviously, past performance is not a guide to the future, so here are three plans that I think will be equally well received. Consider these as an additional segment of an existing balanced and diversified portfolio, and consider how they will affect the performance.
The counterparties for the three plans are Santander UK (formerly Abbey), HSBC and Morgan Stanley. If any of these banks go bust during the investment term then the structured investments may return nothing at all, but in these circumstances the implications for the rest of the portfolio need to be considered carefully as there could be dire implications for all investors.
The first investment will mature after six years, potentially creating a gain in the tax year 2016/17 that will be equivalent to 65% of the amount invested. The 65% gain will be earned provided the FTSE is higher on the maturity date than it was at outset. Obviously, we hope and expect that the FTSE will be higher in six years and there is a possibility that it could be significantly higher, in which case the rest of the portfolio will reflect this and show gains in excess of 65%.
However, there is the potential that the FTSE is lower and that the whole portfolio has suffered as a result of continued economic uncertainty or matters as yet unknown. If this is the case, this investment will return the original capital unless the FTSE is more than 50% lower at the end of the six-year term, in which case our investment will give rise to a proportional loss. If the FTSE is 50% lower at the end of six years the implications that such a fall would have on the rest of the portfolio need to be appreciated.
Investment number two is very similar but will mature in the 2015/16 tax year potentially generating a gain of 50%. Again, the only requirement is that the bank is still solvent and that the FTSE 100 index is higher. As with the above, the capital will only be at risk from a market fall if the FTSE is 50% lower at the end of five years.
The third investment will mature in three years' time if the FTSE is 10% higher. If this is the case it will produce a gain of 50% that can be realised in the 2013/14 tax year, or deferred until a subsequent year which could prove beneficial for CGT planning. If the FTSE is not up by 10% in three years, the plan will run for six years, at the end of which, if the FTSE is higher, it will return 130% of any rise. If it is lower, as with other plans, there will only be a reduction to the original invested capital if the FTSE is more than 50% below its starting level.
If you think the capped returns outlined above will ultimately prove to constrain the return of the overall portfolio, then there are many other options that will potentially produce a greater return in positive markets, but these come with a commensurate increase in the risk and potential loss if markets fall. Likewise, if you believe that the risk of these plans giving rise to a loss is too great then perhaps you shouldn't be investing at all. There are other plans that expose the capital to less risk, but, of course, the price for this is lower potential returns.
It is up to the adviser to put their own combinations together to suit their market expectations and client risk profile - a database of most retail structured investments currently on offer can be found on StructuredProductReview.com.
No one knows for sure how the markets will perform over the next decade but I think utilising structured investments in this way, in conjunction with a portfolio that an adviser would ordinarily recommend, will serve to not only provide a degree of defined outcomes at pre-defined dates, which could help tax planning, but also potentially enhance the returns whilst reducing the risk of loss. Ultimately, I think that it would be difficult to argue that such a portfolio will disappoint and I know from experience that it will more often than not prove to be much more palatable to an investor who has been presented with all of the options. If you disagree, perhaps you know the truth that I'm overlooking?
Ian Lowes FPFS
Lowes Financial Management
Consultation closing 15 September
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