Every adviser wants to give the best possible advice, so the time has come to reconsider some of the misconceptions around the use of structured products in equity portfolios.
Against a background of a huge focus on mutual funds, the three most common arguments I hear against the use of structured products in equity portfolios are:
- My clients are willing to sit out the downturns to benefit over the longer term, so why would we pay for capital protection we do not need?
- I don’t like the inherent credit risk
- They are term products, I need to be able to buy and sell at any time.
There is a widespread misconception that structured products have to include an element of protection. It is true that where there is protection built in there is a cost and it will reduce the upside potential. However, if there is no protection, the money saved can be used to enhance the upside.
If an investor is concerned about bank credit risk, there must be a serious question mark over why they are in equities in the first place.
The securities used to issue structured products will rank above the equity of the issuing bank. If an investment bank fails, we can take it as read that the rest of an investor’s equity portfolio is going to be in pretty bad shape as well. So equity investors, by definition, must be comfortable with credit risk.
In terms of buying and selling, structured products aimed at the professional market are usually listed on a recognised exchange where they can also be traded if they are set up to do so.
The issuing bank will make prices in the security throughout the trading day, so trading is straightforward, with live prices if required.
Given that these concerns are mitigated, let’s look at an example of structures that might appeal to equity investors.
For the bullish investor we have the Supertracker. This type of product provides investors with a leveraged upside return. In exchange for taking on a downside the same as the underlying asset, say, the FTSE 100 Price index, and the credit risk of the issuing bank, the investor has an upside that will be a multiple of the return from the index. In recent times it has been possible to create notes with 300 per cent exposure to the FTSE 100 price index on the upside with a 1:1 downside in price terms, issued by an investment-grade rated bank.
The Supertracker demonstrates that structured products can form part of a conventional risk portfolio; they can be created on most liquid assets, equity, commodity, foreign exchange and interest rates; and the returns can be tailored to meet specific client objectives.
Adrian Neave is partner at Hilbert Investment Solutions.