During the last six to eight months, market volatility was the order of the day. More so for clients who had investment portfolios with strong offshore exposure. This is nothing out of the ordinary and being invested in a global investment portfolio will require investors to sometimes stomach extreme market volatility as seen recently.
Tech stocks, which have by and large been the darlings of the global market for the last 10 years, gave away almost half of their value from the recent all-time highs. Rising inflation in the US and supply chain backlogs have caused numerous economic problems, and as you could have probably predicted, the pain from the initial hard lockdowns in 2020 is only starting to burst through the cracks now. The money-printers in the US also started to cool off, meaning the ‘easy money’ is being taken out of the economy and the cash that was thrown at these tech-darlings has dried up.
Investors who are currently sitting on cash (both locally and offshore) are stuck between a rock and a hard place. Keeping your money in cash will leave it to the inflation-wolves and exposing your capital to the financial markets seems like an extremely great way to lose your money as well. It is almost as though investors need to make the following decision:
- lose 7% per year in cash, or
- lose 17% a year on the stock market.
Building wealth for the long-term eliminates option A above because inflation is a guaranteed way to lose the purchasing power of your money. Keeping capital in cash will get you nowhere. You are not taking on any risk, and hence will be rewarded as such. You must play the hand being dealt to you.
Investors looking for above-par returns will need to move their asset allocation higher up the risk curve to avoid a stagnant portfolio. After all, the biggest risk is not taking any risk.
The answer to this problem? A structured product provides a capital guarantee while presenting upside exposure to the global equity market.
What is a structured product?
A structured product is a five-year equity-linked investment product linked to growth in diversified global equity markets. This structure is run by a given company (Investec/Momentum etc.) and varies in its structure and constitution. Various structured products are available in the market, some with more equity exposure than others. Some products also have a different participation rate on the upside than their competitors. The initial investment period for these products is a term of five years.
Investec is providing principal preservation to investors’ capital through its bond issuance, but only if held to maturity. Profits on the product are locked in at each phase, meaning that when new shares are issued in the company, whatever investors have earned up to that point is preserved should they elect to hold the shares for a second phase and not sell them.
For example, a structured product offered by Investec via the East Asian Growth Basket, provides 100% capital guaranteed at the maturity date after five years with a 40% basket growth cap. In simple terms, your return on investment for the following three scenarios will be as such:
1: THE FIRST ROW: represents a downside scenario; the index returns -50% after five years, but the investor still has 100% returned, due to the principal preservation.
2: THE SECOND ROW: represents a total return of 30%, and as such, the investor is provided with 130% of their starting capital
3: THE THIRD ROW: continues the scenario. The index provided a 150% return over five years, and the client received 140% of their starting capital.
What is the goal of a structured product?
The biggest competitive advantage of using a structured product is the fact that initial capital is guaranteed, even should the investment value at the termination date be lower than the initial investment amount. See below for a depiction of what happened to investors in the Investec Structured Product during the market correction in 2009.
Volatility affects investment returns, especially when clients react irrationally during volatile market conditions as we are currently experiencing. If an investor had to purchase protection on a Global Equity Index, it would cost investors some 18% of the investor’s initial capital. Investors in structured products such as the East Asian Growth Basket will not incur this cost.
Who should consider this investment product?
Investors currently sitting on cash are busy diminishing the buying power of their capital at approximately 6-8% per year and even higher in the current market and economic conditions. With the possible spike in fuel price around the corner (R3/litre), inflation will most likely be higher for the short to medium term.
Therefore, alternatives need to be looked at from an investor’s point of view. Current market volatility is said to remain a factor at least in the short to medium term, and investors with a long-term investment horizon who stick to their plan will reap the rewards. However, some investors are more risk-averse by nature and do not want to expose their capital to the full force of the financial markets. This is where these structured products add extremely great value to investors, by protecting their initial capital against the said volatility, and giving them great exposure to the upside risk in the portfolio.
Below is an excellent indication of the historical performance (November 2004 – March 2022) of a similar structured product by Investec (the Optimal Investment Growth Basket). The graph indicates that with every maturity/roll of the share the investor managed to lock in profits and reduce risk as the new expiry value at maturity becomes the new 100% protected value of the new share at maturity (if investors elected to roll the investment forward.)
Because the investor has a known expiry worst-case value, he/she can avoid mid-term volatility. If markets collapse the investors can avoid loss by being paid out the minimum capital protected value.
Investors are usually faced with two typical investment choices; investment in shares – which have historically provided a better return than interest but with volatility along the way and capital at risk – or investment in, say, an interest-bearing investment or fixed deposit account in the bank. The latter provides capital protection and known interest payments.
Market volatility and market pullbacks to this day and age remain the best opportunity for investors to get a good entry position into the financial markets. The current pullbacks should be seen as a great time to increase certain market positions, especially for the long run.
Nevertheless, structured products also provide an excellent opportunity for the risk-averse investor who does not want to expose all their capital to equity markets, especially on a global scale. Other investors might have a short- to medium investment objective and might simply not be able to expose their capital in full to financial markets. The structured nature of these products mentioned above provides these investors with the perfect opportunity to cash in on rising market opportunities while giving them the peace of mind of protected capital at maturity in the worst-case scenario.
Investing in these products should be done in conjunction with a professional financial/investment advisor, as various structured products are available at different asset managers, with each having its own technical differences.