Blurb: As global markets enter a new era marked by heightened volatility and lower growth, investors are increasingly turning to alternatives to help diversify their portfolios. Can structured products provide the perfect blend of stability and returns in uncertain times?
Constructing an investment portfolio is often thought of as a balancing act between gaining exposure to higher risk, higher return equities and lower risk, lower return fixed-income investments.
But 2022 has shaken the long-standing 60/40 investment playbook, which sought to minimise risk while still providing returns during market volatility.
As the ultra loose central bank monetary policies that have characterised global markets for decades met with repeated inflation surprises, both equities and fixed income investments declined at the same time in a manner not seen since 1969.
The global economy is widely expected to experience significant headwinds in the aftermath, and global equity markets should display heightened volatility. This is why investors are increasingly looking for alternative ways to diversify their portfolios.
Structured products are well suited to the current, uncertain, global market environment. This since they offer a blend of risk protection against markets falling, with attractive returns when markets perform.
As demand for this once niche alternative to traditional asset classes continues to grow, it’s becoming clear that structured products are here to stay.
Structured products demystified
The range of structured products available to retail investors is broad and diverse. Insurers, banks and investment companies issue numerous local and global products every year, each with differing characteristics and return profiles.
In each case, the issuer of a structured product creates specific pay off profiles that strike a balance between risk and return. As they are fixed term investments with a set date of maturity, structured products are generally considered buy and hold instruments.
In general, the risk/return balance of structured products is derived through a trade off between downside protection – the degree to which the investor is protected from losses if markets fall – and upside participation – the degree to which investors are rewarded if markets perform.
For instance, a structured product with a high degree of protection might guarantee investors that their capital would be protected regardless of market performance. However, it may only offer a limited return if markets perform.
Conversely, a product that offers limited protection against losses might offer returns that, in some instances, significantly exceed that which direct exposure to markets would have provided.
In essence, structured products are appealing to investors as they can provide a payoff that can be significantly different to what traditional markets can offer.
Regardless of the payoff profile, structured products are, by design, typically used as a complement to a well diversified investment portfolios. They may be particularly attractive when equity markets are expensive or volatile, as has been the case globally in recent years.
For investors considering their options when it comes to structured products, it is always a good idea to consult with a financial adviser. Investors should also keep in mind some of the important trade-offs as compared to more traditional investments while fully taking into account the terms and conditions of the product before investing.
Structured products explained through illustrative cases
Discovery Invest offers a range of structured products that cater to the respective risk appetite of investors, their preferred investment currency and market exposure.
The Discovery Capital 200+ is an example of a structured product that offers a degree of protection if markets underperform, but a potentially significant return if markets are just flat or positive.
The Capital 200+ is a fixed term investment that gives clients 100% return after five years before the effect of fees and taxes. This is provided that the underlying portfolio of global shares is flat or moves up by the end of the five year period.
Historically, the Capital 200+ has seen investors in its July 2014, May 2017 and September 2017 tranches get the 100% return on their investment over just five years before the effect of fees and taxes, where all their respective underlying global portfolios were up by less than 25% over five years. The March 2015 tranche matured in the midst of the COVID-19 pandemic and provided clients with crucial downside protection in one of the most volatile market conditions to date.
If the portfolio performs exceptionally well, so does the investment, as there is an unlimited upside potential for growth above 100%.
Therefore, a product such as the Discovery Capital 200+ may be suited to investors who have a view that global equity markets will be flat or improve over the next five years.
Furthermore, the Discovery Capital 200+ qualifies for Discovery’s boost of up to 20% on its lump sum Endowment.
Another key benefit is that the capital protected nature of the investment means that investors are provided with some downside protection.
Following the success of the Capital 200+, Discovery Invest is preparing the release of its successor, the Discovery Capital 200|300+. Just like its predecessor, the new product offers an attractive 100% return if the underlying global share portfolio is flat or positive over the period. However, it extends the upside potential by offering another 100% return if the underlying global portfolio achieves growth of 40% or more as well as unlimited upside participation above the possible 200% return.
Downside protection is still offered, provided that the global portfolio does not fall by more than 30% during the five year investment period.
Taken together, this class of structured products offers exceptional returns when markets perform positively over five years which, historically, is the most likely scenario, while still protecting investors if markets perform poorly, though, not terribly.
The Discovery Enhanced Yield Fund is another example of a structured product offering both potentially enhanced returns alongside risk protection, while providing indirect exposure to the United Kingdom (UK) equity market.
The product provides clients with a gross return of 17% after an investment period of one year if the Financial Times Stock Exchange (FTSE) 100 Index, excluding dividends, is flat or positive at the end of that year.
The FTSE 100 Index tracks the performance of the 100 largest companies listed on the London Stock Exchange (LSE) by market capitalisation.
If the FTSE 100 Index provides a negative return after one year, no amount is paid after the first year. The gross return on the Discovery Enhanced Yield Fund will be increased by another 17% and will become payable at the end of the second year if the index is positive. This continues for five years. If the index return is below 0% at the end of each of the years in the five year period, downside protection is provided for falls of up to 30%.
During the third year of investment for the January 2020 tranche of the Discovery Enhanced Yield Fund, the FTSE 100 Index was positive by a mere 1,64%. This resulted in clients receiving a cumulative return of 51% before fees and taxes.
The Discovery Dollar Capital+ is a five year product that provides exposure to the performance of both the European and United States of America (US) equity markets in US dollars. In this way it effectively provides protection against the devaluation of the currency, but not of the underling equities. The product comprises the EURO STOXX 50 and Standard and Poor's (S&P) 500 price indices. If the global portfolio is flat or positive at the end of the period, the Discovery Dollar Capital+ provides clients with 40% growth in US dollars before the effect of fees and taxes.
The Discovery Dollar Capital+ December 2017 tranche global portfolio had a cumulative return of 19.1% over the five year period, which resulted in the fund providing 40% growth in US dollars before the effect of fees and taxes. Based on the rand/dollar exchange rate at 15 December 2022, the date of maturity, the return equates to a growth in rands of 82.73% before fees and taxes. The April 2016 tranche also provided clients with a 40% return in USD over five-years.
The Discovery Dollar Capital 50:50 Plus is a global investment based on a global share portfolio of US and European companies. If this global share portfolio is flat or goes up by as little as 1% over five years, clients will get a 50% growth return in US dollars. If the global share portfolio goes up by more than 50% over five years, clients will get another 50% growth return in US dollars. If the global share portfolio goes up by more than 100%, clients will also participate in any upside. There is also conditional downside protection for falls of up to 30% during the five-year period.
Currently, we have three open tranches of the Discovery Dollar Capital 50:50 Plus, showing the possibility of providing clients with 50% growth in USD at the end of the tranches’ five-year terms.
When considering a structured product, outcomes can vary significantly depending on product design and features. This is why product selection and financial advice are key to achieving a desirable investment outcome.
The dramatic gains achieved in the examples referenced here, relative to their respective indices or underlying global portfolios, are historical instances and not guaranteed outcomes.
Despite this, the potential for enhanced returns at reduced risk that these examples demonstrate is something of a holy grail in investing. They highlight the growing appeal of this once-niche alternative to traditional asset classes.
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