The reasons are obvious; investors are risk averse and leveraging and growth products are on the nose. But so are inflows into equities and growth-orientated managed funds; cash is king in the current environment. But the doomsayers should take a deep breath – and have look at what has happened in the UK where these products, despite a similar bad press post the GFC, are attracting pounds as investors react to low interest rates and volatile markets and engage their clients using structured products.
Based on the UK experience, there’s no reason to believe they will lose their ongoing appeal in our market.
So assuming an investor’s risk profile and investment strategy justifies a structured product, how can it work inside a balanced portfolio?
Let’s take, for example, an SMSF with $1m in funds under management – the average SMSF balance according to the tax office – and an adviser and trustee who is 'bullish' on the equity market.
For trustees of this SMSF, a structured product offers the opportunity to capture the potential for equity market upside for an outlay of the interest payment (less any coupons received). This, for example, in a $1m portfolio could be around $15,700 for the equivalent of $100,000 exposure (10% of the portfolio) – and only 1.57% of the fund’s capital. Here’s how it could work for a product using the S&P/ASX 200 index.
The fund invests $7,900 upfront, which is the interest to gain $100,000 exposure to the S&P/ASX 200 index over three years. In the following two years the fund has to pay $3,900 each year ($7,900 interest less a $4000 coupon payment made to the investor each year), for a total payment of $15,700 over the three years. For the above portfolio this would increase the exposure to the S&P/ASX200 by 10% for a known downside outcome.
During the same three-year period the $1m in defensive assets could have generated a yield of $60,000 a year or $180,000 over the three-year period – and this $180,000 more than pays for the exposure to the S&P/ASX 200.
There is a downside, but it’s manageable while offering trustees the opportunity to tap into the equity markets’ potential upside without significantly altering the fund’s asset allocation and preserving the capital, and most of the income, that funds their immediate needs.
I would argue that as part of an overall strategy, either defensive or growth-orientated structured products can assist in achieving the trustee’s goals.
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