Wednesday, August 10 2022

Over the past six to eight months, market volatility has been the order of the day. More so for clients who had investment portfolios with high offshore exposure. This is nothing out of the ordinary and being invested in a global investment portfolio will require investors to endure extreme market volatility at times, as seen recently.

Tech stocks, which have been overall global market darlings for the past 10 years, are off nearly half their value from recent all-time highs. Rising inflation in the United States and supply chain backlogs have caused many economic problems, and as you probably could have predicted, the pain of the first hard lockdowns in 2020 is only beginning to burst through the cracks. fillet now. Note printers in the US have also started to cool down, meaning ‘easy money’ is being taken out of the economy and the cash that was thrown at these tech darlings has dried up. .

Investors who are currently sitting on cash (both locally and overseas) are stuck between a rock and a hard place. Keeping your money in cash will leave it to the wolves of inflation and exposing your capital to the financial markets also seems like a great way to lose your money. It’s almost as if investors had to make the following decision:

  1. lose 7% per year in cash, or
  2. lose 17% per year on the stock market.

Building long-term wealth eliminates option A above, because inflation is a guaranteed way to lose the purchasing power of your money. Keeping capital in cash will get you nowhere. You take no risk and will therefore be rewarded as such. You must play the hand dealt to you.

Investors looking for higher than normal returns will need to move their asset allocation further up the risk curve to avoid a stagnant portfolio. After all, the greatest risk is to take no risk.

The answer to this problem? A structured product offers a capital guarantee while presenting a positive exposure to the global equity market.

What is a structured product?

A structured product is a five-year equity-linked investment product linked to the growth of diversified global equity markets. This structure is managed by a given company (Investec/Momentum etc.) and varies in its structure and constitution. Various structured products are available in the market, some with more exposure to equities than others. Some products also have a different upside rate than their competitors. The initial investment term for these products is five years.

Investec provides capital preservation for investors through its bond issuance, but only if held to maturity. Profits on the proceeds are locked in each phase, meaning that when new shares are issued in the company, whatever investors have earned so far is preserved if they choose to hold the shares for a second phase. and not sell them.

For example, a structured product offered by Investec through the East Asian Growth Basket, offers 100% capital guarantee at maturity after five years with a basket growth cap of 40%. Simply put, your ROI for the following three scenarios will be like this:

1: THE FIRST ROW: represents a bearish scenario; the index returns -50% after five years, but the investor still has a 100% return, due to capital preservation.

2: THE SECOND ROW: represents a total return of 30%, and as such, the investor has 130% of his starting capital

3: THE THIRD ROW: continue the storyline. The index provided a return of 150% over five years and the client received 140% of his starting capital.

What is the purpose of a structured product?

The main competitive advantage of using a structured product is the fact that the initial capital is guaranteed, even if the investment value on the termination date is lower than the initial investment amount. See below for a description of what happened to Investec structured product investors during the market correction in 2009.

Volatility affects investment returns, especially when clients react irrationally in volatile market conditions such as we are experiencing today. If an investor were to buy protection on a global equity index, it would cost investors about 18% of the investor’s initial capital. Investors in structured products such as the East Asian Growth Basket will not have to bear this cost.

Who should consider this investment product?

Investors currently sitting on cash are busy reducing the purchasing power of their capital by around 6-8% per year and even more under current market and economic conditions. With the possible fuel price spike approaching (R3/litre), inflation will most likely be higher in the short to medium term.

Therefore, the alternatives must be considered from the perspective of the investor. Current market volatility should remain a factor, at least in the short to medium term, and investors with a long-term investment horizon who stick to their plan will reap the rewards. However, some investors are inherently more risk averse and do not wish to expose their capital to the full force of the financial markets. This is where these structured products add tremendous value to investors, by protecting their initial capital against said volatility, and giving them great exposure to the upside risk of the portfolio.

Below is an excellent indication of the historical performance (November 2004 – March 2022) of a similar structured product from Investec (the Optimal Investment Growth Basket). The chart shows that with each expiration/rollover of the stock, the investor has successfully locked in profit and reduced risk, as the new expiration value at maturity becomes the new 100% protected value of the new stock at maturity (if investors have chosen to roll the investment forward.)

Since the investor has a known worst case expiration value, he can avoid mid-term volatility. If the markets crash, investors can avoid losses by receiving the payment of the minimum value protected by the capital.

Investors are generally faced with two typical investment choices; investing in stocks – which have historically provided a better return than interest but with volatility along the way and capital at risk – or investing in, for example, an interest-bearing investment or a time deposit account at the bank . The latter offers principal protection and known interest payments.

Summary

The market volatility and pullbacks to date remain the best opportunity for investors to gain a good entry position in the financial markets. The current pullbacks should be seen as an ideal time to increase certain positions in the market, especially in the long term.

Nevertheless, structured products also constitute an excellent opportunity for the risk-averse investor who does not wish to expose all his capital to equity markets, particularly on a global scale. Other investors may have a short or medium term investment objective and may simply not be able to expose all of their capital to the financial markets. The structured nature of these products mentioned above provides these investors with the ideal opportunity to take advantage of rising market opportunities while giving them the peace of mind of principal protection at maturity in the worst case scenario.

Investment in these products should be made in conjunction with a professional financial/investment adviser, as various structured products are available from different asset managers, each with their own technical differences.

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