Liontamer’s faith in Fallen Angels
The Independent, May 28, 2008


Chalkie has a vivid memory of sitting through an excruciatingly boring presentation a few years ago aimed at explaining an OM-IP capital guaranteed investment product managed by British-based Man Group (which sponsors the Man Booker literary prize).

That type of product is mind-numbingly complicated – a quick check of their latest prospectus shows Chalkie nothing much has changed.

Chalkie prefers the “keep it simple, stupid” maxim, particularly for retail products aimed at the most unsophisticated of investors, such as capital guaranteed investments.

So when the investment statement for another couple of capital guaranteed (or capital protected) products came across her desk – Liontamer’s Fallen Angels Series 1 and Combi Series 5 issues – Chalkie was predisposed to take a dim view of them.

For a start, Chalkie thinks the very concept of capital guaranteed investment products is nothing more than a con designed to take advantage of those unsophisticated investors worried about doing their dough.

Given the legacy of the 1987 sharemarket crash instilling in “mum and dad” investors a pathological dislike of sharemarkets, this is particularly the case when such products are equity-based.

Typically the minimum investment is $5000. The investment term can vary greatly but is usually five years. In the case of the current Liontamer offerings, the term is likely to be between five and six years.

The “capital protection” feature works like this. Investors are guaranteed to get their $5000 back at the end of the term, regardless of how well or poorly the underlying investment fares.

If inflation averages 3% a year, that $5000 is worth only $4426.47 in today’s dollars after five years and just $4293.68 after six years.

If the investment fares poorly it isn’t just the erosion of capital the investor suffers. They also lose the return they could have received from investing elsewhere.

Mum and dad investors have good reason to eschew finance companies these days but there are plenty of good quality fixed-interest investments offering more than 10%. Bonds listed on the NZX which fit the bill include those of Infratil, Powerco and South Canterbury Finance. The latter’s five-year bonds, issued late last year with a 10.43% coupon and rated “BBB-“ by Standard and Poor’s, were trading at 10.35% last week, indicating the market thinks they’re a particularly good deal.

That same $5000 invested in a 10% bond for five years would return the original $5000 and $2320.50 in interest after five years and $3052.55 after six years.

Those offering capital guaranteed products typically put enough into a fixed-term deposit, say 60% of the funds invested, to ensure the interest paid in the meantime will bring back the sum back to the face value of the sum invested by the time the products mature.

The length of the investment term is determined by how long it takes. They use the remaining 40% to gear up or buy derivative products to achieve a better return than the deposit will yield. Such derivatives are hardly the type of products mum and dad investors are likely to be comfortable with, let alone understand. Without the “capital guarantee” part of the deal, they probably wouldn’t look twice at such investments.

Typically, the fees charged for such products are much higher than for other managed funds. But Chalkie’s objection to the “capital protection” lark aside, the Liontamer product is much more straight-forward and investor-friendly than she expected.

That’s largely because the investment statement doesn’t even attempt to explain how Liontamer and its 51% owner, Belgian KBC Bank, makes the investment work or how they profit from it. The Fallen Angels’ proposition is investors will get the percentage increase in 16 international stocks over the period of their investment term. The 16 stocks include eight non-US-based financial companies, such as Credit Suisse, ING and UBS, and other stocks such as General Electric and Toyota, all of which have been heavily sold after the US credit crunch.

The 16 stocks fell between 4.17% (pharmaceuticals company Eli Lilly) and 57.55% in the year ended March 7. If the stocks continue to fall during the first six months of the investment term the starting point will be reset at the three or six-month point as an investor’s starting point. The investment rationale is these stocks have probably been over-sold and will recover over time because the companies involved are basically sound businesses.

Chalkie reckons that’s a reasonable proposition. If investors are particularly confident about the outlook, they have the option of having only 90c in the $1 “capital protected” and getting 130% of the gains in the 16 stocks as the trade-off.

The Combi offering is investors will get between 105% and 150% of the percentage increase at which the actual amount is set at the start of the investment period in a basket of six commodities, oil, natural gas, sugar, wheat, corn and soyabeans, over the investment term.

Would-be investors need to decide whether they think that already rampant oil and other prices are likely to rise further to work out whether this one is worth a punt, but that’s still a straightforward decision.

The only fee charged is an entry fee up to 3% of the sum invested and that goes to the investor’s financial adviser (not Liontamer) who is free to rebate some or all of the fee back to the investor. (An exit fee of 2% is charged if the investor requires Liontamer to repurchase, rather than redeem, the investment at maturity. The choice is driven by tax considerations.) Liontamer co-founder and investment director, Janine Starks compares her company’s product to a bank deposit: banks don’t explain to investors how they operate behind the scenes to ensure they make a profit on a term deposit. They simply offer a set interest rate for a set period.

“You don’t say to a bank, ‘how are you going to provide me with 8% interest?’ In our case, it’s exactly the same. Our fund owns a piece of paper that promises our money back plus a formula of market returns. They (KBC and other investment banks) have a legal responsibility to pay us that money,” Starks says.

Since KBC has an “AA-“ credit rating from Standard and Poor’s it’s unlikely to default.

The only money Liontamer gets out of the deal is whatever KBC pays it for raising the money, and Liontamer pays financial advisers 2% brokerage out of whatever KBC pays it. KBC makes its money by taking margins in financial markets.

Starks says the Liontamer funds don’t use gearing, instead buying call options to gain the desired investment exposures. If these options are out of money at the end of the investment period they aren’t exercised but the investor still gets face value back.

One advantage to a New Zealand investor is although they’re exposed to the performance of international stocks or commodities, they don’t have any foreign currency exposure. Everything is locked in at the start of the investment and what matters is the underlying performance of the stocks or commodities.

The Fallen Angels and Combi offerings are Liontamers 26th and 27th funds. Two of the three issued in its first year have easily exceeded 10% annual returns so far and the third was only slightly less. They mature between July 2010 and November 2011.