Strong returns and risk mitigation – structured products’ holy grail
It was Victor Hugo who said that nothing is more powerful than an idea whose time has come, and as an investment tool, structured products certainly fit that description. Once regarded as a niche product for a small group of investors, more and more financial advisers are finding it to be a powerful way of managing risk while delivering meaningful returns at the same time.
Brian McMillan, head of structured products at Investec Corporate and Institutional Banking, says advisers are increasingly turning to structured products as an integral part of a retirement portfolio. Because many structured products are linked to foreign indices, they are a particularly useful way to help clients to build up the offshore component of their portfolio.
“And thanks to the capital protection mechanisms built into many structured products – most offer either full or substantial protection against market declines – they are a highly effective tool for hedging risk for clients approaching retirement,” notes McMillan.
The attractions of structured products as a risk management tool may create the impression that investors need to sacrifice significant upside to achieve their goals. However, McMillan notes that structured products have a track record of not just removing downside risk, but also delivering significant upside returns.
McMillan says an analysis of Investec’s structured products over the years have shown that they have, in most cases, delivered superior returns for investors than the underlying indices.
He says that of the 81 Investec-issued products that have matured over the years, none have lost investors any capital, while 90% have provided investors with positive returns.
“Over the last 10 years, Investec’s structured products have produced an average annualised return of 11.2% in rand terms, compared to 8.1% per annum on the respective underlying price indices, an outperformance of 3.1% a year,” he notes. “This is a noteworthy performance given that the JSE Top 40 index has barely compensated investors for inflation over the past few years.”
“At the same time, when we compare with offshore markets, investors have outperformed reference indices in each of the respective currencies with a 3.58% outperformance in British pounds, 2.32% in Australian dollars and 1.49% in US dollars (all returns quoted as average annual returns),” he adds.
A number of Investec’s recently matured products have been particularly rewarding for investors. For example, three recently matured products linked to the Eurostoxx 50 have significantly outperformed the underlying index in rand and euro terms.
“For example, a four-year digital structured product referencing the Eurostoxx 50 returned investors 70% on their initial capital. This compares to a 33.4% rand return that you would have earned in an index-tracker on the index over the same period. In other words, an investment in the structured product would have earned an investor an excess return of 8.1% a year over the underlying index.”
On a three-year digital structured product, also referencing the Eurostoxx 50, investors earned 63.5%, compared with 23.5% in rands on an index-tracking investment. “This amounts to an excess return of 11.8% a year over the underlying,” he adds.
Sonia Lynch, from the structured products team at Investec Corporate and Institutional Banking, expects structured products to continue to grow in importance as an investment planning tool in the years to come. One reason is the shift in market conditions in the coming years. “As governments and central banks face the challenges of the world economy, such as rising inflation and the need to normalise policy, so volatility becomes a more important factor for advisers and their clients,” she says. “Investment tools that can protect against capital loss should continue to be attractive.”
Furthermore, investors will increasingly want to invest in emerging themes in the coming years. Lynch notes for example the growing demand for investments that address environmental, social and governance (ESG) issues. “Investors are increasingly conscious of the impact that climate change and growing inequality, for example, are likely to have on our lives in the future, and want to invest in ways that promote a sustainable future,” she says.
Structured products can address these issues in an elegant way, she says, citing the example of Investec’s China Seas Basket, a three-year and 10-month investment that references the Euronext CDP Environmental World Index, a globally recognised ESG index. Lynch notes that investing in companies that rank highly on an ESG basis have outperformed the market by up to three percentage points a year, according to research last year by Bank of America Merrill Lynch.
“The China Seas Basket is an excellent example of how ESG-conscious investors can fulfil their investment and sustainability goals through one investment,” she says.
Lynch says the key is for structured product providers to continue to seek out themes that make sense for investors in an increasingly complex world. “The point to note is that thanks to the gearing that is possible through a structured product, capital protection need not come at the cost of performance. Combined with the ability to track emerging investment themes in an efficient way, this should be attractive to investors.”
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