How to protect equity returns from below-par performance

With equities struggling to stay bullish, this could be a good time to seek out vehicles that deliver positive returns even when the markets are falling.

This month’s product

METEOR FTSE SPX SUPER STEP-DOWN KICK OUT PLAN 2019

One of the main benefits of structured products is that they can offer a positive return even if equity markets fall over time. That is the case in this plan. It offers a positive return even if the main UK and US equity market indices fall by up to 35% over six years. For investors who think returns from equity markets are likely to be below average, the potential return of 7.4% for each year up to the date of maturity will be attractive compared with prospective returns from other assets.

The plan is offered by Meteor, one of the leading independent plan managers in the UK. Investors will buy a note issued by US investment bank Morgan Stanley with an investment grade BBB+ credit rating. This means that it is considered to have an adequate capacity to meet its financial commitments but may be susceptible to changing economic conditions. For our purposes this provides assurance that the issuer is very unlikely to default.

The conditions to be met

The value of the plan is linked to the performance of UK and US equity markets. Specifically, the return is conditional on both the FTSE 100 and the S&P 500 indices meeting certain specific conditions described below.

The plan can last for a maximum term of six years and investors should be prepared to invest for the full term. However, it may mature early or ‘kick out’ at the end of each anniversary of the date on which the levels of each index are initially recorded.

If it runs to maturity, there are three possible outcomes. The best result is that both indices are above 65% of the initial levels recorded on 22 February 2019. If this is the case, investors receive their initial investment plus 51.8%. This is a return of 6.1% per year. If one or both indices has dropped by more than 65% but neither has dropped by more than 40%, investors receive 100% of their capital but no return. Finally, if there has been a meltdown and either of the indices has dropped by more than 40%, then the maturity value will be reduced in line with the performance of the worse-performing index.

The plan is unlikely to last to the maturity date, however. Its kick-out feature means that investors may receive their money back plus a positive return on any anniversary. For the plan to kick out, both indices must be above a set level on that anniversary. This level starts at 105% at the end of the first year and declines by 5% every year, so it is 100% after two years, 95% after three years, 90% after four years and 85% after five years. If this condition is satisfied, the plan winds up at that point and investors receive their money back plus 7.4% for each year they have held it.

The back-test shows that a plan like this would have kicked out at the end of the first year over 60% of the time. The stress test is more cautious and indicates a 37% chance of a kick out at the first anniversary, but still a 95% chance of a positive return.

Positive return history

Using historic data this plan has always offered a positive return. The average annual return is 7.1%. The stress test data, which is typically a little more cautious, shows there is a 95% chance of a positive return – in which case the average return is 7%. There is a 1% chance of no gain and no loss, and a 4% chance of loss, in which case the average maturity value is 49%.

If investors want to compare it with other investments, using the historic data, the average return is 6.9%. Using stress test data, the volatility of returns is 7%, equivalent to a fund with about 50% equity exposure. The average return is 5.3%, factoring in the chance of no return and a loss.

This type of structured product is among the most popular, and it is easy to see why: it offers a high chance of a positive return and a low chance of loss. The Meteor plan is one of the best in the market now, based on the risk/return profile, and is offered by a reliable manager with a long history of good service using a note from a high-quality issuer. For investors who want an asset that can offer a good return if equity market returns are low, this will be an attractive choice.

How to buy the plan

The product can be bought through several execution-only brokers, including:

BestPrice: bestpricefs.co.uk/structured-products

Money World: moneyworld.com/structured-investment-products/

Cavendish Online: cavendishonline.co.uk/

WealthME: wealthme.com/investments-and-services/structured-products/

David Stuff­ is managing partner at Levendi Capital.

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