While stockmarkets have been beset by a succession of crises, rising and falling on a frequent basis, and effectively tracking sideways, autocalls have been providing annualised returns of 10%-12% (and for those willing to accept greater risk with their investment sometimes more). They have done that when benchmarked against indices that during some of the same investment periods have struggled to get into positive territory.
One of the potential advantages of autocalls, of course, is that while they are 5-6 year investments offering a fixed annual percentage return, they can mature early at set anniversaries (usually from years 1-2), giving the investor the chance to achieve known returns in a shorter time frame.
Over recent years, this has enabled advisers who have been taking the view that markets were likely to track sideways but eventually would start to recover, to use autocalls as potential short-term investments, hedging their optimistic views with the potential for the markets to remain lacklustre.
At the same time, advisers knew if they called it wrong, the investment would continue with the potential to pay out on future anniversaries and should markets fall, capital would be protected against all but the most extreme market conditions.
Hence, autocalls have been useful tools used in client portfolios to diversify risk and balance out index tracking investments, for example, which have typically suffered from poorer returns in these market conditions.
Here is a summary table from our website that shows how a typical autocall works (including counterparty risk):
An issue for structured product providers at the moment is that spreads (interest rates) are low and volatility is still flat, which making it difficult to price attractive product and offers in general have been lower than they were a year ago. FTSE only autocalls, for example, are offering more around the 7%-8% mark compared to around 10% last year. In addition, many commentators are predicting that markets can and will rise further over the medium to long term.
While these may prove to be fantastic investments, I would urge advisers to also look at some of the other opportunities in the market.
Two growth products that have caught my eye are a deposit based structure offering 1.2% of any rise in the FTSE 100 after 5 years (averaged over the last six months of the investment) and another offering a gain at the end of six years equivalent to the average return of the 11 best performing shares from the 20 largest FTSE 100 companies by market capitalisation.
The first, as a deposit-based structure, secures the investor’s capital against all adverse stockmarket events and has FSCS cover in the event of the counterparty failing. Therefore, should markets tumble – and given recent markets we should not rule out anything – clients would not see their capital eroded as they would in a unit trust tracker fund, for example.
The best five year, fixed-term deposit taken out at this time might produce around 16% interest at maturity. This structured deposit will therefore outperform such an account if the FTSE (subject to final six month averaging) rises by more than 13.5% over the five-year term; much more if markets are favorable but with the surety of a return of at least the original capital if not. Unless you are the ultimate ‘bear’ I am sure you can appreciate how this structure could compliment any investment and deposit portfolio where the client and adviser know that they don’t know for sure how the markets are going to behave over the coming years.
Moving up the risk scale, albeit not significantly, the second structure effectively enables retrospective stock picking, since it uses the average of the 11 best performing shares of the top 20 FTSE 100 companies (by index weighting on 8 May 2013) to calculate the return at maturity. Again there is no limit on the maximum gain that can be achieved.
Unlike many stock based structures, however, in negative market conditions, the return of the original capital is not linked to individual shares (often this can be dependent on the value of the lowest performing share at maturity). Instead, capital is protected unless Morgan Stanley B.V. and Morgan Stanley default and / or the FTSE 100 index is more than 50% down at the end of the six year term. The StructuredProductReview.com summary table for this product is below.
While autocalls have dominated the structured product market in recent years, and may well do so going forward, I would urge advisers not to rule out other products on offer which, given their different levels of capital protection and investment opportunities, could make welcome additions to investment strategies as well as helping to improve diversification and balance in investors’ portfolios.
[These views are for professional financial advisers only. They should not be used by consumers].