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David Stevenson: Marmite funds tempt in choppy markets

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David Stevenson: Marmite funds tempt in choppy markets

Structured products tend to be a Marmite investment idea. Many financial advisers use them as an alternative to a more defensive investment strategy (or even as surrogates for absolute returns funds) while many more think they are over complicated and expensive.

My own view is that structured products are like most other investment product structures, tainted by a long tail of awful plan providers but genuinely innovative in places. I have used structured products in the past – happily – and for full disclosure write a regular economics roundup for the trade association.  

I’m not currently invested in any structured products, but I am beginning to think again about maybe using them as a halfway house between either equities and bonds in a defensive capacity.

The important thing to say about most structured products is that they can be very useful, if, and it is a big if, we are in more range bound market environment with lots of volatility but no obvious bullish rally (or bearish sell-off) in sight. My own sense is that this kind of market is not only possible but probable and that this time next year the FTSE might be within 5% or 10% of where it is now – either way.

If on the other hand you think that stock markets might tank by more than 20% or even 40% you should probably avoid all risk investments – and structured products very much are risk assets – and stick to cash and gilts.

Equally if you think we are due a big equity bull rally, just stick with high beta equity assets such as US equities and ride the bull – most structured products with the exception of growth plans will probably underperform.

So, why do I think that structured products can be useful in a more defensive market? The statistics tell the story. Every year Newcastle-based financial adviser and structured products fan Ian Lowes does a very useful performance review of the alternative space.

We’re probably due the latest iteration but last years numbers for the previous year – 2017 – suggest that the average annualised return was 7%, over an average term for the plan of 3.7 years. Crucially 94% of maturing products produced positive results for investors, with the top quarter returning an annualised average of 10.9% and the bottom 2.7%.

Middle ground between shares and bonds

I tend to think of structured products as a form of defined returns investing where in most years you’ll probably make between 5% and 8% per annum – more than bonds but less than equities in a good year.

The predominant structure is something called an autocall or kick out plan where a plan issuer says they’ll pay you X per cent as a capital gain every year (usually between 5% and 10%) as long as the reference index (usually the FTSE 100) is the same level (or above) at the time the plan was issued.

If in a years’ time it is, the plan kicks in and you get your X%. But if the index has fallen, you have to wait for another year to see if that redemption level for the index is met – if not your potential X% return kicks on to the next year. And so on until the end of the plan.

The downside is related to something called the barrier. If this is breached during a big market fall – and its usually set between 20% or 40% lower than the index used at issue – you could lose your capital, and of course you won’t get those annual payments.

Autocalls are popular with many specialist financial advisers and there are dozens of different structures issued every year. Arguably the choice is so confusing that what’s needed is a fund that buys into the better plans and then provides investors with a blended return across different products.

The good news is that there are a number of these funds around now including one from an issuer, French bank Société Générale, which in effect tracks the FTSE 100.

The biggest fund by far though is from a specialist firm called Catley Lakeman and is called the AHFM Defined Returns fund. In reality it is targeting wealth advisers who want an alternative to poorly performing absolute returns funds (and there are plenty of these!) and has grown markedly in terms of assets under management over the last few years.

Its full of lots of kick out or autocall plans – usually between 25 and 50 – and has lower volatility than the FTSE 100 but more than you’d expect with a corporate bond fund. Assets are now £783 million and fund manager charges 0.55%.

Performance is, sort of, what I’d expect – in 2018 it lost 2% versus the FTSE 100's 8%. Since launch in November 2013 the fund is up 31% against the FTSE 100's 21% total return, while returns in 2017 were 10% and in 2016 11.8%.

The fund managers have run some scenario analyses which suggest that if the UK market has moved nowhere in a years time, the fund will return 6.3%. if the UK market is down 20%, the fund will lose 10%. The December return for the fund was a loss of 4.7%, slightly below the loss for the UK blue chip total return index.

This big fund is really innovative but is primarily targeted at wealth advisers – in the retail world Catley Lakeman has been working with another new firm called Dura Capital which has also been bringing out some interesting new products, mainly aimed at financial advisers.

My own personal favourite

But competition has intensified as other new players alongside Dura have entered the space. Amongst them is Tempo Structured Products which has also been developing new structures – my own personal favourite is something called the Long Income Plan which I have thought very seriously about investing in.

This product or plan offers the potential for income of 5.15% each year, which is payable on each annual income date at which the FTSE 100 closes at or above 60% of the start level. The plan also includes an early maturity feature - if the FTSE 100 closes at or above 125% of the start level on any annual income date from the end of the 5th year, the plan will mature automatically allowing investors to reinvest in an alternative investment idea.

The key idea here is alternative income – the 5.15% payout is well above anything you’d get from a bond or bond fund and I think the chances of the FTSE 100 falling below say 4500 and then staying there for a few years are low (but by no means impossible, especially if we have Corbyn in power). 

Arguably the most innovative idea though in the world of structured products hails from the US. A manager called Innovator Capital Management has taken the idea behind defined returns and turned it into an exchange-traded fund.

In effect it gives you some, capped, upside exposure to the benchmark S&P 500 index but with a defined lower buffer or barrier. The table below maps out the product structure which resets annually and can be held indefinitely.

Ticker Name Buffer level % Cap%* Outcome period
BJAN Innovator S&P 500  Buffer ETF 9 21.51 1/01/19 - 12/31/19
PJAN Innovator S&P 500  Buffer ETF 15 13.11 1/01/19 - 12/31/19
UJAN Innovator S&P 500  Buffer ETF 30 (-5 to -35) 11.21 1/01/19 - 12/31/19

* includes impact of 0.79% fee 

With the first fund for instance, you are protected down to 9% per year over the period but your total return is capped out at 21.51%. Crucially, this is a stock exchange traded fund which you can buy and sell in real time, unlike many structured products sold through financial advisers  in the UK which feature early redemption penalties.

Any opinions expressed by Citywire or its staff do not constitute a personal recommendation to you to buy, sell, underwrite or subscribe for any particular investment and should not be relied upon when making (or refraining from making) any investment decisions. In particular, the information and opinions provided by Citywire do not take into account your personal circumstances, objectives and attitude towards risk.

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