When it comes to structured products, transparency is the name of the game with providers increasingly building in additional protective measures by packaging their funds as Ucits III Oeics, writes Martin Morris
If there was one positive to emerge out of the Lehman Brothers fiasco in September 2008, it was the realisation single counterparty risk was a very real problem and investors, whether they had lost money or not, needed to take note.
Fast forward 18 months and the structured products industry – which did not emerge unscathed from the investment bank’s demise – has had a major house-cleaning exercise. Today, product transparency is the name of the game with providers increasingly building in additional protective measures by marketing their funds as Ucits III Oeics.
While the Ucits III wrapper gives greater regulatory protection to investors, the single-pricing mechanism of Oeics provides added liquidity and flexibility for investors looking to include these funds as part of larger portfolios.
Terms and conditions
Terms and conditions may vary from provider to provider but the core values essentially remain the same – funds having a designated lifespan and pre-determined capital growth and/or income objectives – assuming specified targets are met.
One variant of the structured products theme is the so-called autocall fund. In simple terms, an autocall product is a market-linked investment that can be ‘autocalled’ prior to the investment’s scheduled maturity date, if certain predefined market conditions are met.
Case study one
In the case of CitiFirst Funds’ five-year UK Autocall fund (launched in February and carrying a minimum investment of £10,000 with charges set at 5% initial, 0.9% annual) investors were given the opportunity to potentially receive an initial 18.5% (9.25% pa) after year two, with conditional capital protection, provided the FTSE never closed below 50% of the start level on any business day after the fund was launched.
The autocall date was to be observed annually thereafter, up to and including the fifth anniversary.
If the fund was not autocalled until year five, the strategy was set to return 46.25% with the fund reinvesting the accumulated capital and all proceeds into a new autocall strategy. A new investment cycle with new terms would then begin.
If the final level of the FTSE ended up lower than the start level and the FTSE closed lower than 50% of the start level on any business day, the product’s terms and conditions stipulated the value of the autocall strategy would be reduced by the negative performance of the FTSE. In extreme circumstances (ie if the level of the FTSE were to fall to zero) investors could theoretically lose all of their investment.
To limit counterparty risk the fund has been collateralised with G7 debt. In plain language the investor faces reduced credit exposure to Citi such that if Citi went into bankruptcy there would be zero recourse to the fund or any assets within it by Citi creditors.
Referring to the UK Autocall fund Emma Davidson, head of UK & Ireland retail structured product sales noted over the last couple of years, more and more funds have converted their funds into Ucits III-compliant vehicles.
“We can safely say IFAs will be familiar and comfortable with this highly regulated wrapper,” she says. Adding: “Internally, there are several plans for subsequent funds to be launched into the UK market. We want to make ourselves as flexible as possible as we provide products that fulfill investors’ needs. This will come with constant communication with the advisers and their networks.’’
Case study two
Meanwhile, Aviva Investors’ FTSE-100 Index-linked Defined Returns Fund 3 – a three-year term fund available through 5 March and set to mature on 12 March 2013 – has an investment objective of 18.75% capital growth – this dependent upon the FTSE’s final index level (12 March 2013) being higher than its opening level (12 March 2010).
If, at maturity, the FTSE has fallen by up to 50% of its closing level on March 12 2010, the fund aims to return the client’s initial investment only.
If the fall is greater than 50% however the initial capital will be reduced on a 1% for 1% basis (ie if the final index level has fallen by 60% investors will receive just 40% of their initial investment back).
It is worth pointing out the final index level is determined by the average of the closing level of the FTSE taken on each business day for the three months prior to maturity.
Minimum investment is £1,000 for direct investments, £500 within an Isa. Counterparty risk is fully collateralised.
Case study three
Elsewhere, Morgan Stanley’s Dublin-domiciled FTSE 100 Accumulated Income Fund 1 (launched in January) is targeting semi-annual income payments of up to 3.25% during its five-year lifespan – this in addition to a full return (in theory) of the investor’s initial capital.
Regarding the income portion of the investment, income accrues for every day in each six-month period the index closes between 3,200 and 7,500, up to a maximum semi-annual income payment of 3.25%.
Income payments will correspondingly be reduced for each day the index closes outside this range on a 1% for 1% basis. Hence, if the FTSE closes within this range on 50% of days, the income payment will work out to 1.625% (50% of 3.25%).
If the index closes within the range on all days, investors achieve the maximum income payout of 3.25%.
For the capital element a 1% for 1% basis also applies – in this case should the final level of the index be lower than the index at launch date. Therefore, if the FTSE is 40% lower investors will only receive 60% of their original capital back.
To limit counterparty risk the fund, like others, is collateralised by G7 government bonds.
Fund distributions should be liable to income tax treatment. It is also Isa, Sipp, Ssas, and offshore bond eligible.
Minimum investment is £100 with an annual management fee of up to 0.50%.
The latest launch by Morgan Stanley follows hard on the heels of the three-year FTSE 100 Accumulated Capital Fund 1 late last year, which targeted capital growth of 23% – contingent upon the FTSE trading within a 3,200 to 7,000 range for the duration.
Matthew Robinson, executive director at Morgan Stanley Institutional Equity Division – and co-designer of the products – says the total charge for the latest Oeic is 50bp per annum. The two funds have been sold to discretionary managers such as Brewin Dolphin, along with solicitor firms that have investment management wings.
“We are happy to show the complete pricing breakdown for clients at launch and indeed provided this for several key accounts. These fees do not affect the performance of the fund and 50bp pa is very competitive.
“For the income fund the income is subject to income tax, while the capital element is subject to capital gains tax,’’ says Robinson.
Irrespective of the products on offer there is little doubt further launches will occur in the months ahead as providers come up with deals that are not only more efficient from investment and financial planning standpoints, but also products investors feel more comfortable with.
