Regardless of how much we as advisers repeat the adage that investing should be considered with a long-term horizon, market volatility is always likely to give investors cause for concern.
It can especially become a worry in passive investing, where traditional investments, such as index funds simply follow the market. Structured products, while often linked to the stockmarket, do not directly follow market movements but instead have defined outcomes that will be delivered at defined dates.
The benefits of structured products include the downside protection offered against market falls through full capital protection (in the case of capital protected and structured deposits), or in the case of capital-at-risk products, defined barriers which allow for market falls before capital would be impacted.
It would be an oversimplification to say a particular product type is suitable for a specific market environment as each plan needs to be considered on its own merits.
However, the downside protection built into a structured product, alongside the multiple opportunities for maturity offered by auto-calls, may explain why this product type has been in a sweet spot for advisers over recent years.
Demand for such plans, commonly called “kick-outs”, is likely to continue, especially in volatile markets.
In market conditions that chop and change, this type of structure can deliver positive gains for investors where other investments do not. The nature of auto-calls is they can mature early if predefined conditions are met on a set anniversary (usually annual), where the criteria are checked on these dates. The coupons roll up to create higher returns the longer the product runs.
This early maturity opportunity is why auto-calls usually have shorter durations than growth products that have a fixed term. Looking at the last 500 capital-at-risk auto-call maturities, which span 15 November 2012 to 31 December 2015, these made average annualised returns of 9.12 per cent over an average term of 1.84 years, according to figures from StructuredProductReview.com.
This short duration is a consequence of many of the plans benefiting from favourable market conditions and, as such, maturing well in advance of their maximum durations.
Of course, investors should always be prepared to hold a product full-term as early surrender prices are determined by a number of factors that will on occasion be unfavourable. However, the potential for early maturity offered by auto-calls can help with tax planning, given the known maximum potential pay-outs at defined dates.
As can been seen from the table, products that were linked to measurements other than just the FTSE 100, typically comprising two indices or a basket of shares, for example, have, on average, benefited from the acceptance of the additional risk of linking to alternative underlying measurements, but the range of returns of the non-FTSE 100 only product set has been greater.
The maturity requirement for the underlying measurement to be higher, or with defensive auto calls for it to not fall beyond a certain level, means if we continue to experience markets where there is little growth, auto-call structured products could continue to be among the best-performing investments. Obviously, if the markets steam ahead, then the risk is that auto-call investors miss out on some of the upside.
Whether markets are going to track sideways, dramatically fall or grow over the short to medium term cannot be known with any certainty and lately this has bec-ome even clearer.
An adviser’s role is to build client portfolios that diversify risk to ensure that returns are as consistent as possible over the longer term. Many advisers who have embraced structured products as part of their portfolio propositions have found they rarely fail to meet client expectations, given that, with few exceptions, they do exactly what they say on the tin.
Ian Lowes, Founder, StructuredProductReview.com