Structured products: Auto-calling the shots

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Auto-calls have been popular with advisers and currently make up the majority of structured products offered in the financial adviser market. This is possibly because these products can mature on defined dates with defined gains in the event of moderate market rises or, in certain cases, moderate falls. 

Such products maturing with a gain in the event of a slight market fall are described as defensive in nature, which means that they can mature when the market is, say, 95 per cent of the initial level on a pre-set anniversary. An auto-call may have a maximum term of six years but can mature early on specific anniversary dates, if pre-set conditions defined in the product terms are met. 

Another reason for auto-call popularity may be that they have tended to regularly outperform other product types. Looking at maturities over the past five years to 31st July 2015, the 633 maturing capital at risk auto-calls distributed through the adviser space made an average annualised return of 9.2 per cent over an average term of 1.74 years, according to figures from StructuredProductReview.com.

By comparison, capital-at-risk growth products, which are designed to be held for the full, typically six-year, fixed term, have over the same time period delivered an average annualised return of 7.66 per cent over an average term of 4.65 years. There were 250 such products maturing.

The early maturity features of auto-calls means that given positive markets, the investment duration is likely to be less than for other investments.  Utilising a series of auto-calls in a portfolio alongside a series of growth products will not only diversify counterparty exposure but will also see regular, potential maturities and staggered capital gains, which in many cases with careful planning can help reduce the tax burden on the gains significantly through the use of capital gains tax allowances.

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Maturity proceeds can either be used to meet capital or income requirements at that time or, reinvested in either rollover substitutes from the same provider, an offer from another provider or directly into the markets through other investments. Where the gains have been produced in sideways markets, the auto-call returns have resulted in significant outperformance. 

While the majority of this product type have their returns dictated by the FTSE 100 Index only, they do not participate in the performance of the index, but instead use it as a proxy to dictate whether a maturity is triggered. In the event that the FTSE rises significantly then, of course, with hindsight it would have been better to have been directly invested, but a direct investment is a completely different beast, offering no downside protection or defined outcomes.

That said, auto-calls will rarely be to the exclusion of direct, equity-linked investments but instead will form part of a portfolio and where returns of between 6 per cent and 10 per cent per annum are targeted they can work well. Higher potential returns can be achieved from auto-calls linked to multiple indices or baskets of individual shares but, of course, this additional potential return is a function of the additional risks.  

Each product will have its own distinctive features and advisers and investors will, as ever, need to ensure that the products utilised are appropriate for the investors’ needs and in line with their market outlook.  

It’s understandable that advisers who have, thus far, steered clear of such investments will be reluctant to change, but I don’t think I’m too far off the mark in suggesting that those investment advisers who have been appropriately using auto-calls in their client portfolios for some time will have very happy clients.

Key Takeaway: Auto-calls tend to have shorter terms than other products, due to their nature, but have higher annualised gains. However, investors should use them alongside other products to balance out requirements.