Structured Products
Delivering in Troubled Times
Clive Moore
Managing Director
Investment Design and Distribution
1
Investment Design and
Distribution
Established 2002
Consultancy with banks
Private Client Managers
Fund of Fund Managers
Family Offices
Some International
International
Principal Focus since 2008
2
Objectives

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Learn about the history of Structured
Products
Develop an understanding of how
structured products work
Why they continue to deliver marketbeating returns.
3
Warning!!

The following may make your head hurt a
little
• Don’t panic – you can get copies if you’re
interested
• Ask questions as we go

It won’t take long
• Most people remember some of it
• It’s actually easier than most people think
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What is a Structured Product?

An investment that delivers returns in a different way to
direct investment in the underlying asset.
• Generating higher income instead of capital growth
• Providing capital protection on ‘higher potential’ asset classes
• Enhancing returns from modest market gains
• Backing investment views in a concentrated way
• Accessing hard-to-buy asset classes
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Investor Attitude
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Rate Fixation
Legacy of Building Society retail funding requirement – they
had to get so much money from retail investors before they
could borrow any institutionally – so heavy rate competition
(different to most other countries).
Short Termism
British are eternal financial optimists, a better “rate” is just
around the corner, so don’t like to “tie-up” their money too
long.
Like to buy products they think they understand,
rather than take advice – poor image of financial
advisers, reluctance to discuss personal finances.
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Popularity of Structured
Products

Short and defined term
Often promoted with a “headline” rate
Good value (normally half the price of OEIC/UT)
Passive investment (not paying to underperform)
Variety of structures to suit particular needs
Terms are fixed at outset
Generally easy to understand and evaluate

Deliver returns in sideways markets
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Massive Popularity with
Wealthy Clients

Capital preservation is paramount
• Preserve hard earned capital
• Deliver easy to understand payoffs to investors who
aren’t that interested in their portfolios
• Clients looking for ‘cash plus’ return
• Ability to deliver tailored solution for client needs
• Focus on absolute return to retain client relationship
8
Counterparty Collapse
Banks took on too much risk
• Management focussed on sales – retail background led
to desire to sell more loans (tins of beans) without credit
considerations.
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Counterparty issue hadn’t been clearly presented
or understood
Nothing is risk-free
Advisers should pay attention and cover their
rears!
If it looks too good to be true…
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The Component Parts

“Cash”
• Medium Term Notes/Zero Coupon Bonds. Debt issued by
banks. Just like corporate bonds. Options normally embedded
in the MTN. Counterparty issue!

Call options
• The right (but not the obligation) to buy something at a
predetermined price at a point in the future.
• For example, the right to “buy” the FTSE 100 at 6000 points in
5 years time.

Put options
• The right to sell something at a predetermined price at a point
in the future.
• For example, the right to “sell” the FTSE Index at 6000 points
in 5 years time.
Option normally embedded in structure.
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Constructing Structured
Products
Simple Growth Product:

100p received from Investor: What gearing can be afforded?

Total margin of 5p to cover commission, marketing costs etc.

6 year Zero costs 83p (6 year interest rates at 3.2%)
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Leaves 100 - 83 - 5 = 12p to buy FTSE upside

6 year FTSE Call option costing 20p
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Gearing that can be offered = 12/20 = 60%
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Building Blocks
Simple Cash + Call
E.G. Full capital return plus 60% FTSE growth
Possible Bonus
100%
100%
Call Options
Charges
Cash (MTNs)
100% Capital Return
Provides Capital
Return
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Constructing Structured
Products
Income Plan:

100p received from Investor: What income can be afforded?

Total margin of 5p to cover commission, marketing costs etc.

5 year Zero costs 85.5p

1% income for 5 years costs 4.6p

So annual income of 7% costs 32.2p

So cost is 122.7p!
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Sell 5 year FTSE 100 Put Option = 22.7p (lose 1:1 at maturity
if Index ever below 50% of start value)
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Building Blocks
Cash minus Put
E.G. 7% income each year,
but lose 1 for 1 if Index lower
Put Option Premium
100%
Charges
Variable Capital
Return
Max 100%
Max 100%
Cash
(MTNs)
Provides
Capital
Return and
Income
5 x 7% Income
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Features
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Capital Protection
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•
•
•
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‘Soft’ protection – as long as the worst Index has never been
below 50% of its start value.
Check barrier level – is 60% a 40% drop or 60% drop?
American option = below 50% at any point.
European option = below 50% at maturity.
Early Kick-Outs
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•
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Early maturity with bonus if certain levels achieved.
Auto-call products, single or multiple underlying.
Coupon Counter/Podium payoff – income/growth hybrid.
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Features
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Stock Baskets
•
•
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Counterparty Risk
•
•
•
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Returns linked to a basket of stocks/indices/commodities can give
more diversification.
Remember, single shares can collapse completely, but indices never
die – they just change constituents.
‘Riskier’ banks will pay higher returns (better looking products, wider
margins).
Think of your excuse in case things go wrong.
Always ask – you should always be told.
Always Ask
•
•
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Why is it different to everything else?
Make sure you understand the payoff in different scenarios.
Complexity may not be a bad thing, but check.
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Why the Bad Reputation
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Bad news makes a good headline.
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Compensation culture – everyone’s a victim if there’s money in it.
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PR from “vested interest groups” – Threat to traditional funds.
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“I thought it was guaranteed” - Well pay attention can’t you read!
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Execution only sales
Should have spoken to an adviser, or bought a product you understood!
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Products “sexed up” to look better than they were.
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Counterparty issue not clearly highlighted.
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Some providers too greedy – Inappropriate counterparties used.
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Investor Emotion Index
Annual Return
Emotion
>12%
Mildly enthusiastic
+9%
Neutral
+3%
Surly (worse than cash)
0%
Relieved if markets down
-5%
Positively hopping mad
<-7%
Murderous
Good to outperform, but better not to underperform
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Investment Backdrop
Developed equity markets lagging – particularly UK
Changes in capitalism
• Shares were owned by people with a vested interest in their
long term performance (company pension funds etc.)
• Shares now owned by Fund Managers – interest only in
relative performance
• Fund manager income from stock-lending (which also
encourages downward speculation)
• Focus on attracting new investments.
10 year FTSE flat – CEO remuneration up 400%*!!
• Too many snouts in the trough.
*Source Manifest MM&K
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10 Year Fund Performance
Total number of funds
18,154
Funds with 10 year record
4,217 (23%)
10 year growth greater than
5% p.a.
2,047 (11%)
10 year growth greater than
10% p.a.
676 (4%)
Source: Morningstar 16th September 2011
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Simplicity Leads to Success
Product should be understandable in 2 paragraphs
Remember, most investors are used to building society
savings accounts
Best to use recognisable underlyings
Everyone likes a headline rate
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The IDAD Difference
How have the IDAD notes performed so far?
Year of
Issue
Autocalls
Issued
(GBP, USD,
Euro)
Matured By
First
Anniversary
2008
3
3
0
2009
16
15
6
1
2010
40
25
17
11
2011
59
Annualised
Ongoing >
Return
exceeded year 1 since
issuance
index
Ongoing <
year 1 since
issuance
4
59
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Structured Products
Delivering in Troubled Times
Details of our current offers are available on our
website – www.idad.biz
Or contact our IDAD Sales contact
Or email: enquiries@idad.biz
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Structured Products
Delivering in Troubled Times
Clive Moore
Managing Director
Investment Design and Distribution
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