Investor complacency, over-valuations, macro-economic developments and ongoing central bank policy suggest to several managers that our investment team speaks to that a high level of cash is a sensible strategy and that we are in the proverbial stock picking market.
In this market investors will be seeking alternative means to achieve positive growth. I would suggest structured autocalls (or kick outs) are an obvious option. In particular, for this article, I’d like to focus on autocalls that have as their underlying benchmark the FTSE 100.
Although investments with five or six year terms, autocall’s allow for early maturity of the product if certain market conditions are met, typically that at one of a set number of monitoring points the index is above its level recorded at the outset of the investment (the strike point). Importantly, most products only need the index to be a fraction above the strike point to pay out the defined return – which normally is a fixed percentage of the capital invested.
In addition, investors know exactly what they will receive and when and under what market conditions. An example product might offer a fixed 8.5% gain from the second anniversary of the product as long as the FTSE 100 is above the strike point. At the second monitoring point therefore, the product would return 17% on capital, if the index were above the strike point.
If the index was not above the strike point at the monitoring date, then the product rolls over for another year, when the same criteria applies. In our example case, increasing the pay out to a 25.5% gain.
The roll-over continues until the end of the product term when, if the index has still not recovered to a position above the strike point, normally the product will pay back capital in full, while some products make a minimum end of term payment or pay the full five to six year roll over amount to the investor.
Hence, when the index is undulating as at present, having a complementary investment vehicle that has the ability to produce returns when markets are effectively flat can be a useful tool for advisers to use as a proportion of investors’ portfolios.
In addition, of course, structured products also offer different levels of capital protection. When looking at payouts of 8.5% as in our example, this is likely to be a capital-at-risk product, which typically will offer full capital protection against market risk unless the market falls by a set percentage, for example, up to 50% from the strike level. Deposit-based autocalls will offer 100% protection against market risk but as a result of the additional protection, are likely to offer lower defined returns.
Alongside this, there are risks to be considered, primarily credit risk, in that structured products invariably have an underlying counterparty and the pay out is dependent on the counterparty being solvent at whatever date the product matures.
Having laid out the benefits of autocalls, the question is how have they performed of late? StructuredProductReview.com conducts regular analysis of the structured product market and we recently concluded an analysis and comparison of performance in H1 2014 with H1 2013.
With the caveat that past performance is no guide to the future, of the 73 FTSE 100 autocalls that matured in 2013, the average annualised return was 8.2% (first quartile average was 11.48%). The average time to kick out was 2.17 years.
In the first six months of 2014, of the 48 FTSE 100 autocalls that matured, the average annualised return was 8.7% (first quartile average was 11.68%) and the average time to kick out was 1.5 years.
It is no surprise that autocalls have proven to be the most popular structured products over the past few years. While their returns will not have been as attractive in a rising market, albeit still a useful risk diversifier in investors’ portfolios, with markets potentially looking range bound for the foreseeable future they could once again come fully into their own.
