2018: Equity markets fall, Structured products prosper

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2018: Equity markets fall, Structured products prosper

2018 was a very bad year for equities with all major indices falling significantly, particularly in the final quarter of the year. The overall results for 2018 have the Eurostoxx 50 as the biggest faller of the three major indices to which structured products are linked in the UK with a decline of 14.3%. This was followed by 12.5% for the FTSE-100 and 6.2% for the S&P-500. While the S&P-500 may have been relatively steady over the year as a whole, this masks the fact that it rose sharply to be followed by severe losses in Q4 (13.9%).

Even allowing for dividends reinvested this represents significant real losses across all indices. In addition market volatility was much higher during most of last year than in 2017 (as measured by the VIX for example).

It would be wrong to describe UK structured products as completely insulated from falls in equity markets since by definition all structured products link to an underlying asset such as an index. While these products will have suffered some short term falls as reflected in the secondary market and statement reporting values in the last twelve months the most popular product types in the UK are very resilient to such market conditions. Most products are auto-calls with a one or two year first call point often with a defensive feature built in allowing some market losses to be absorbed.

Evergreen auto-calls

Why have auto-calls proven so successful and popular in recent years? In simple terms the extra yield is generated by risk to capital that will come into play only if markets fail to rise at any future anniversary and suffer a substantial loss at maturity. Historically this has happened very few times. The investment banks that issue such products are able to hedge their exposure in equity and options markets meaning that they do not expect to lose money either even when they pay out good returns and this maintains the viability of these products for future issuance.

A selection of products started one or two years ago show that many are poised to successfully call and in doing so outperforming both equities and cash. This is a common scenario in flat or mildly declining markets demonstrating that these investments are an extremely good choice for low to medium risk investors seeking to beat low cash rates.

Recent examples

Issued 2 years ago, Societe Generale SG UK Step Down Kick-Out Plan 29 (report 4044 on our Structured Edge service) just missed a 2 year Auto-call but is set to return 22.65% in 12 months time (representing 7.04% p.a.) if markets are flat or better,

Also from 2 years ago, Investec Structured Products FTSE 100 Defensive Kick-Out Plan 38 (report 4052) which is well placed to call in 12 months at its first opportunity even if the FTSE-100 falls a few percent more and will return 23.25% (7.22% p.a.).

Meteor FTSE Step Down Kick Out Plan December 2017 was launched 12 months ago and missed its first call which required market growth of 5% but is well placed to call successfully in subsequent years if markets are flat or slightly up because the target levels reduce over time.

Looking ahead

Despite the falls in equities in 2018 few would be brave enough to suggest an immediate bounce back and therefore structured products such as auto-calls remain well positioned to offer attractive returns at lower risk with the prospect of a steady procession of fixed returns over the next few years. In other words, the rationale and successful performance of these structured products is no fluke or reliant on special market conditions but a reflection of the tough investment landscape that has persisted for ten years or more.

As well as the prospect of successful maturities auto-calls provide a simple efficient strategy of targeted returns with precisely known risk levels in terms of index values. Many financial advisers welcome the flexibility that structured products can provide for their lower risk clients. Experience over many years has demonstrated the power of this strategy in volatile and unpredictable markets. As advisers seek to provide their clients with alternatives to model portfolios which will always struggle in such circumstances the popularity of auto-calls and other structured products should increase in 2019.

Tags: Investment Special Reports Structured Edge

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