When stock indexes level are high, there is always a fear that optimism could fail and markets could go sideways, blip or even show a correction. The economic tide can always turn and macro events could send the market into jitters.
One of the reasons behind diversification of portfolios is to reduce their market risk, which is why growth structured products are considered for a diversified portfolio, as geared market participation can lead them to outperform more traditional passive investments, such as index funds.
However, it is worth bearing in mind that a sideways market will still see an index fund deliver around 3% per annum from dividends.
Consider this example: if over the next six years the FTSE rises by 5% or more, there are growth structured products that will produce a 60% gain. For any investor or adviser neutral or moderately bullish over the medium term, growth structured products are an option in light of the returns potential.
Defensive nature
Multiples on participation in the rise in the underlying asset can vary widely. Also, some growth products are defensive in nature, which means that rather than the underlying asset, usually an index, needing to be higher for the product to mature with a gain, it can produce gains as long as the final level is not more than 10% down from the initial level. Other product types often also have this defensive feature.
Growth structured products usually have a cap on returns. However, as far as this is concerned, I and most investors would be delighted to achieve the maximum return.
This is not a negative, but a best case scenario when also considering the downside protection offered by structured products. Capital-at-risk products usually have a protection barrier of 40% or 50%, which the underlying asset has to fall beyond for capital to be put at risk.
Deposits offer capital protection, as do capital 'protected' products, providing the counterparty remains solvent. With the opportunity for geared exposure to a rise in the underlying asset, alongside protection to the downside, it is clear how growth product exposure could be a good way to hedge your bets on market movements.
As opposed to an auto-callable*, which can mature early if pre-defined conditions are met, growth products have a fixed term and so they have longer average terms than auto-calls.
Looking at auto-calls over the last five years, they have average terms of around a year-and-a-half to two years, while growth products have an average of around five years.
The majority of launches in the last five years have been auto-calls, but while growth products are more rare, the longer average term could be a major benefit for those that believe markets will tread water for a while, but rise over the longer term.
Maturities
Looking at the growth product maturities over the last five calendar years including 2015, it is clear that these products have performed better in more buoyant market conditions.
The growth products that matured in 2010 delivered an average annualised return of 2.73% over an average term of 4.07 years, while last year, it was 6.7% over 5.09 years.
Of the 122 growth products that matured in 2010, 78 made a gain for investors, 44 returned capital only and none made a loss. While in 2014, nearly 91% of the 217 products made a gain for investors, while 18 returned capital only and 2 made a loss.
Considering the most recent maturities, out of the 58 growth products that have matured this year to the end of April all have made a gain for investors, bar one which returned capital only.
The average annualised return of these products, which includes deposit based plans, was 6.95% over an average term of 4.83 years. The top quartile of these products made an average annualised return of 10.24%, while the bottom quartile made 4.48% per annum.
This difference in the quartile performance highlights how it is important that each product should be considered on its individual merits and potential outcomes. Product types can be a starting point for considering client needs and market views of an investment adviser.
Source - investmentweek.co.uk
*An autocallable, which is the abbreviation of "automatically callable", is a feature of an exotic option. This feature is often found in structured products with longer maturities. A product with an autocallable feature would be called prior to maturity by the issuer if the reference asset is at or above its initial level (or any other predetermined level) on a specified observation date. The investor would receive the principal amount of their investment plus a pre-determined premium (often paid out in the form of a coupon) and the autocallable product is said to be redeemed early.
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