Should you surrender your structured product?

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One issue that crops up in structured products is how surrender prices are determined and how investors assess whether it’s viable to sell out early.

While investors that buy a structured product must be willing to hold the product to maturity, one of the myths is that they are purely a buy-and-hold investment. Investors commit to the terms to be delivered on preset maturity dates, but this does not mean early surrenders are not possible, or sometimes advisable.

The surrender price of a structured product is ultimately determined by the issuing bank, the next possible maturity date and the likely outcome at that date.

To help illustrate this, StructuredProductReview.com has analysed FTSE 100 linked digital growth plans maturing over the next five years. Such a product may offer a 55 per cent gain at the end date if the FTSE is higher than at the beginning, a return of the original investment if the index is lower, unless it is 50 per cent lower, in which case the investment would track the fall in the index. All products analysed have the 50 per cent protection barrier.

In the chart, the product’s time until maturity is considered against how the surrender value compares to the maximum maturity price. The orange bubbles are plans that have HSBC as counterparty, while the red ones are Morgan Stanley-backed.

The longer the remaining duration, the lower the surrender price and, therefore, all other things being equal, the greater the potential gain to maturity. The cluster of products at the left hand side do not have long until maturity and as the FTSE 100 has been trading above the level needed, the surrender prices are close to the target maturity value. 

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Another factor influencing pricing, albeit to a lesser degree for investments further from maturity, is the extent to which the index is currently above its strike level. This is illustrated by the size of the bubbles: the larger bubbles indicate more ‘headroom’ above the relevant hurdle level and as such, a greater chance that the investment will mature with a gain. This in turn should lead to an improved surrender value. 

The funding rate and the pricing policy of bank will also play a part in dictating the surrender values. 

Looking at two extremes let’s consider the HSBC-backed Legal & General Four Year Growth Plan 1. This plan works as detailed previously but with a potential 35 per cent gain. The product will mature on 20 March 2017 with a ‘unit’ price of £1.35 if the FTSE is above 6,481.50, £1 if below this but above 3,240.75, and less than 50p if the market is below this level. At the time of writing the FTSE is only 323 points above the required level to produce the £1.35 maturity and accordingly the surrender price is set at £1.11.

The Morgan Stanley FTSE Defensive Digital Growth Plan 5 is a six-year plan, launched at a FTSE level of 5,318.60. It gives a 56 per cent gain at maturity, providing the FTSE 100 closes at no more than 20 per cent below its initial level. It will mature on 21 September 2017 with a ‘unit’ price of £1.56 if the FTSE is above 4,254.88, £1 if below this, but above 2,659.3 (50 per cent below the initial level) and less than 50p if below this. As the FTSE is currently more than 2,500 points above the strike level for a £1.56 payout, the surrender price is higher than L&G’s at £1.42. This translates to the current surrender value increasing by 4.28 per cent a year, even if the FTSE falls by the equivalent of 18.9 per cent a year between now and the final maturity date.

While there are many influencing factors, if the surrender value rose to the point that the potential annualised gain to maturity fell below say 3 per cent per annum (shown by the green dotted line) we may well consider selling out early.

Obviously the right course of action for any individual will depend on their personal circumstances, the reason for investing, their other assets and perhaps more importantly, what they expect to do with the proceeds.

Key takeaway: Structured products should not just be considered a buy-and-hold investment. Surrender values depend on time to maturity, the issuing bank and current FTSE levels.

Ian Lowes is founder of StructuredProductReview.com