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Transcript of 1 Structured Products Delivering in Troubled Times Clive Moore Managing Director Investment Design...
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Structured ProductsStructured ProductsDelivering in Troubled TimesDelivering in Troubled Times
Clive MooreClive Moore
Managing DirectorManaging Director
Investment Design and DistributionInvestment Design and Distribution
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Investment Design and Investment Design and DistributionDistribution
Established 2002Established 2002Consultancy with banksConsultancy with banksPrivate Client ManagersPrivate Client ManagersFund of Fund ManagersFund of Fund ManagersFamily OfficesFamily OfficesSome InternationalSome International
InternationalInternationalPrincipal Focus since 2008Principal Focus since 2008
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ObjectivesObjectives
Learn about the history of Structured Learn about the history of Structured ProductsProducts
Develop an understanding of how Develop an understanding of how structured products workstructured products work
Why they continue to deliver market-Why they continue to deliver market-beating returns.beating returns.
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Warning!!Warning!!
The following may make your head hurt a The following may make your head hurt a littlelittle• Don’t panic – you can get copies if you’re Don’t panic – you can get copies if you’re
interestedinterested• Ask questions as we goAsk questions as we go
It won’t take longIt won’t take long• Most people remember some of itMost people remember some of it• It’s actually easier than most people thinkIt’s actually easier than most people think
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What is a Structured Product?What is a Structured Product?
An investment that delivers returns in a different way to An investment that delivers returns in a different way to direct investment in the underlying asset.direct investment in the underlying asset.
• Generating higher income instead of capital growthGenerating higher income instead of capital growth
• Providing capital protection on ‘higher potential’ asset classesProviding capital protection on ‘higher potential’ asset classes
• Enhancing returns from modest market gainsEnhancing returns from modest market gains
• Backing investment views in a concentrated wayBacking investment views in a concentrated way
• Accessing hard-to-buy asset classesAccessing hard-to-buy asset classes
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Investor AttitudeInvestor Attitude
Rate FixationRate Fixation
Legacy of Building Society retail funding requirement – they Legacy of Building Society retail funding requirement – they had to get so much money from retail investors before they had to get so much money from retail investors before they could borrow any institutionally – so heavy rate competition could borrow any institutionally – so heavy rate competition (different to most other countries).(different to most other countries).
Short TermismShort Termism
British are eternal financial optimists, a better “rate” is just British are eternal financial optimists, a better “rate” is just around the corner, so don’t like to “tie-up” their money too around the corner, so don’t like to “tie-up” their money too long.long.
Like to buy products they think they understand, Like to buy products they think they understand, rather than take advice – poor image of financial rather than take advice – poor image of financial advisers, reluctance to discuss personal finances. advisers, reluctance to discuss personal finances.
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Popularity of Structured Popularity of Structured ProductsProducts
Short and defined termShort and defined term Often promoted with a “headline” rateOften promoted with a “headline” rate Good value (normally half the price of OEIC/UT)Good value (normally half the price of OEIC/UT) Passive investment (not paying to underperform)Passive investment (not paying to underperform) Variety of structures to suit particular needsVariety of structures to suit particular needs Terms are fixed at outsetTerms are fixed at outset Generally easy to understand and evaluateGenerally easy to understand and evaluate
Deliver returns in sideways marketsDeliver returns in sideways markets
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Massive Popularity with Massive Popularity with Wealthy ClientsWealthy Clients
Capital preservation is paramountCapital preservation is paramount
• Preserve hard earned capitalPreserve hard earned capital
• Deliver easy to understand payoffs to investors who Deliver easy to understand payoffs to investors who aren’t that interested in their portfoliosaren’t that interested in their portfolios
• Clients looking for ‘cash plus’ returnClients looking for ‘cash plus’ return
• Ability to deliver tailored solution for client needsAbility to deliver tailored solution for client needs
• Focus on absolute return to retain client relationshipFocus on absolute return to retain client relationship
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Counterparty CollapseCounterparty Collapse
Banks took on too much riskBanks took on too much risk• Management focussed on sales – retail background led Management focussed on sales – retail background led
to desire to sell more loans (tins of beans) without credit to desire to sell more loans (tins of beans) without credit considerations.considerations.
Counterparty issue hadn’t been clearly presented Counterparty issue hadn’t been clearly presented or understoodor understood
Nothing is risk-freeNothing is risk-free Advisers should pay attention and cover their Advisers should pay attention and cover their
rears!rears! If it looks too good to be true…If it looks too good to be true…
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The Component PartsThe Component Parts ““Cash” Cash”
• Medium Term Notes/Zero Coupon Bonds. Debt issued by Medium Term Notes/Zero Coupon Bonds. Debt issued by banks. Just like corporate bonds. Options normally embedded banks. Just like corporate bonds. Options normally embedded in the MTN. in the MTN. Counterparty issue!Counterparty issue!
Call optionsCall options• The right (but not the obligation) to buy something at a The right (but not the obligation) to buy something at a
predetermined price at a point in the future. predetermined price at a point in the future. • For example, the right to “buy” the FTSE 100 at 6000 points in For example, the right to “buy” the FTSE 100 at 6000 points in
5 years time.5 years time.
Put optionsPut options• The right to sell something at a predetermined price at a point The right to sell something at a predetermined price at a point
in the future.in the future.• For example, the right to “sell” the FTSE Index at 6000 points For example, the right to “sell” the FTSE Index at 6000 points
in 5 years time. in 5 years time.
Option normally embedded in structure.Option normally embedded in structure.
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Constructing Structured Constructing Structured ProductsProducts
Simple Growth Product:
100p received from Investor: What gearing can be afforded?
Total margin of 5p to cover commission, marketing costs etc.
6 year Zero costs 83p (6 year interest rates at 3.2%)
Leaves 100 - 83 - 5 = 12p to buy FTSE upside
6 year FTSE Call option costing 20p
Gearing that can be offered = 12/20 = 60%
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Building BlocksBuilding Blocks
CallCall Options Options
100% Capital Return100% Capital Return
Possible BonusPossible Bonus
ChargesCharges
Cash (MTNs)Cash (MTNs)
Provides CapitalProvides CapitalReturnReturn
Simple Cash + CallSimple Cash + Call
E.G. Full capital return plus 60% FTSE growthE.G. Full capital return plus 60% FTSE growth
100%100% 100%100%
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Constructing Structured Constructing Structured ProductsProducts
Income Plan:
100p received from Investor: What income can be afforded?
Total margin of 5p to cover commission, marketing costs etc.
5 year Zero costs 85.5p
1% income for 5 years costs 4.6p
So annual income of 7% costs 32.2p
So cost is 122.7p!
Sell 5 year FTSE 100 Put Option = 22.7p (lose 1:1 at maturity if Index ever below 50% of start value)
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Building BlocksBuilding Blocks
PutPut Option Premium Option Premium
5 x 7% Income5 x 7% Income
VariableVariable Capital Capital ReturnReturn
Max 100%Max 100% ChargesCharges
Cash Cash (MTNs)(MTNs)
Provides Provides CapitalCapitalReturn and Return and IncomeIncome
Cash minus PutCash minus Put
E.G. 7% income each year,E.G. 7% income each year,but lose 1 for 1 if Index lowerbut lose 1 for 1 if Index lower
100%100%Max 100%Max 100%
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FeaturesFeatures
Capital ProtectionCapital Protection• ‘‘Soft’ protection – as long as the worst Index has never been Soft’ protection – as long as the worst Index has never been
below 50% of its start value.below 50% of its start value.• Check barrier level – is 60% a 40% drop or 60% drop?Check barrier level – is 60% a 40% drop or 60% drop?• American option = below 50% at any point.American option = below 50% at any point.• European option = below 50% at maturity.European option = below 50% at maturity.
Early Kick-OutsEarly Kick-Outs• Early maturity with bonus if certain levels achieved.Early maturity with bonus if certain levels achieved.• Auto-call products, single or multiple underlying.Auto-call products, single or multiple underlying.• Coupon Counter/Podium payoff – income/growth hybrid.Coupon Counter/Podium payoff – income/growth hybrid.
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FeaturesFeatures Stock BasketsStock Baskets
• Returns linked to a basket of stocks/indices/commodities can give Returns linked to a basket of stocks/indices/commodities can give more diversification.more diversification.
• Remember, single shares can collapse completely, but indices never Remember, single shares can collapse completely, but indices never die – they just change constituents.die – they just change constituents.
Counterparty RiskCounterparty Risk• ‘‘Riskier’ banks will pay higher returns (better looking products, wider Riskier’ banks will pay higher returns (better looking products, wider
margins).margins).• Think of your excuse in case things go wrong.Think of your excuse in case things go wrong.• Always ask – you should always be told.Always ask – you should always be told.
Always AskAlways Ask• Why is it different to everything else?Why is it different to everything else?• Make sure you understand the payoff in different scenarios.Make sure you understand the payoff in different scenarios.• Complexity may not be a bad thing, but check.Complexity may not be a bad thing, but check.
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Why the Bad ReputationWhy the Bad Reputation Bad news makes a good headline.Bad news makes a good headline.
Compensation culture – everyone’s a victim if there’s money in it.Compensation culture – everyone’s a victim if there’s money in it.
PR from “vested interest groups” – Threat to traditional funds.PR from “vested interest groups” – Threat to traditional funds.
““I thought it was guaranteed” - Well pay attention can’t you read!I thought it was guaranteed” - Well pay attention can’t you read!
Execution only salesExecution only salesShould have spoken to an adviser, or bought a product you understood!Should have spoken to an adviser, or bought a product you understood!
Products “sexed up” to look better than they were.Products “sexed up” to look better than they were.
Counterparty issue not clearly highlighted.Counterparty issue not clearly highlighted.
Some providers too greedy – Inappropriate counterparties used.Some providers too greedy – Inappropriate counterparties used.
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Investor Emotion IndexInvestor Emotion Index
Annual ReturnAnnual Return EmotionEmotion
>12%>12% Mildly enthusiasticMildly enthusiastic
+9%+9% NeutralNeutral
+3%+3% Surly (worse than cash)Surly (worse than cash)
0%0% Relieved if markets downRelieved if markets down
-5%-5% Positively hopping madPositively hopping mad
<-7%<-7% MurderousMurderous
Good to outperform, but better not to underperformGood to outperform, but better not to underperform
Investment BackdropInvestment Backdrop
Developed equity markets lagging – particularly UKDeveloped equity markets lagging – particularly UK
Changes in capitalismChanges in capitalism• Shares were owned by people with a vested interest in their Shares were owned by people with a vested interest in their
long term performance (company pension funds etc.)long term performance (company pension funds etc.)
• Shares now owned by Fund Managers – interest only in Shares now owned by Fund Managers – interest only in relative performancerelative performance
• Fund manager income from stock-lending (which also Fund manager income from stock-lending (which also encourages downward speculation)encourages downward speculation)
• Focus on attracting new investments.Focus on attracting new investments.
10 year FTSE flat – CEO remuneration up 400%*!!10 year FTSE flat – CEO remuneration up 400%*!!• Too many snouts in the trough.Too many snouts in the trough.*Source Manifest MM&K *Source Manifest MM&K
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2020
10 Year Fund Performance10 Year Fund Performance
Total number of fundsTotal number of funds 18,15418,154
Funds with 10 year recordFunds with 10 year record 4,217 (23%)4,217 (23%)
10 year growth greater than 10 year growth greater than 5% p.a.5% p.a.
2,047 (11%)2,047 (11%)
10 year growth greater than 10 year growth greater than 10% p.a.10% p.a.
676 (4%)676 (4%)
Source: Morningstar 16Source: Morningstar 16thth September 2011 September 2011
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Simplicity Leads to SuccessSimplicity Leads to Success
Product should be understandable in 2 paragraphsProduct should be understandable in 2 paragraphs
Remember, most investors are used to building society Remember, most investors are used to building society savings accountssavings accounts
Best to use recognisable underlyingsBest to use recognisable underlyings
Everyone likes a headline rateEveryone likes a headline rate
The IDAD DifferenceThe IDAD Difference
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Year of Issue
Autocalls Issued (GBP, USD, Euro)
Matured By First
Anniversary
Annualised Return exceeded
index
Ongoing > year 1
since issuance
Ongoing < year 1 since
issuance
2008 3 3 0
2009 16 15 6 1
2010 40 25 17 11 4
2011 59 59
How have the IDAD notes performed so far?How have the IDAD notes performed so far?
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Structured Products Structured Products Delivering in Troubled TimesDelivering in Troubled Times
Details of our current offers are available on our Details of our current offers are available on our website – www.idad.biz website – www.idad.biz
Or contact our IDAD Sales contactOr contact our IDAD Sales contact
Or email: Or email: [email protected]
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Structured Products Structured Products Delivering in Troubled TimesDelivering in Troubled Times
Clive MooreClive Moore
Managing DirectorManaging Director
Investment Design and DistributionInvestment Design and Distribution