Providing clients with 'best advice'
As you begin to use structured retail products with your clients, it's important to consider how they fit into both new portfolios and existing fully invested portfolios. These products are often very innovative and provide you with a structure of risks and returns which simply can't be created using traditional funds. Therefore they command attention. Providing your clients with 'best advice' is paramount and as more and more products come to market you need to carefully weigh up their purpose and function.
Below we discuss a number of topics relevant to our two new investments:
Click on the links in red to go directly to that section:
Choosing between SUPERgrow 150 and EASYgrow 85
Restructuring portfolios with SUPERgrow 150 and EASYgrow 85
Choosing between SUPERgrow 150 and EASYgrow 85
Four Questions to ask
When using structured products, confusion often exists over when to use a partially protected product versus a fully protected product. While you can make the decision as complicated as you like, here are a few easy questions to ask:
1. Does my client have exposure to equities?
If yes, look immediately to SUPERgrow 150 and use the accelerated upside as a recovery solution. This type of solution is not available via any other product.
2. Would the client benefit from lowering portfolio risk further?
If yes, next look to EASYgrow 85 and use the full protection to lower risk and the unlimited upside potential (85% of market growth) to compliment the recovery product.
3. Has the client got new money to invest?
If so, consider a SUPER / EASY combination, so the client is positioned to take advantage of low, medium and high growth environments in the future. Vary the proportions depending on your own view.
4. Does my client have exposure to cash and bonds or an over-exposure to property which needs correcting?
If yes, look to EASYgrow 85 and use the full protection as an incentive to draw money away from traditional term deposits and bond funds which are now suffering from adverse interest rate conditions
SUPERgrow 150, why it's likely to be favoured
In the majority of client portfolios we anticipate that there will be a natural home for both EASYgrow 85 and SUPERgrow 150. However, in the current climate we believe SUPERgrow 150 is likely to be the most widely used or more heavily weighted in terms of the product split. Why?
Here are 5 reasons:
- The majority of clients do hold equities and have suffered losses which need recovering
- Remaining entirely in traditional funds/shares is not a proactive recovery solution (remember a 40% fall, requires a 67% recovery in percentage terms!)
- Access to structured products with accelerated upside has never been available before. The structure of rewards and risks simply can't be recreated with traditional funds
- The 40% protection barrier will be welcomed by the vast majority of clients. It provides a significant buffer against any further market shocks and provides a risk reduction tool which is not available via other funds. Most clients in equity funds have only ever had fully exposed downside risk
- Unless we are totally bearish, most of us believe in two scenarios for sharemarkets - the more consensus view of low to medium growth or a more aggressive bull run. Financial advisers can't afford to ignore either possibility, so clients' portfolios have to be positioned to take advantage of both outcomes to one degree or another. There are very few investments which will provide superior returns in a low to medium growth environment, but the acceleration provided by SUPERgrow 150 fulfills the role. It is designed to be a core holding and advisers can consider using it fairly aggressively in restructuring existing portfolios.
Anecdotal evidence from the UK also shows us that when accelerated growth products were introduced, financial advisers absorbed enormous volumes and implanted them into the majority of client portfolios. They were commanding up to 80-90% of business volumes and were being primarily used to restructure existing portfolios.
Restructuring portfolios with SUPERgrow 150 and EASYgrow 85
When a new and innovative investment comes along, it's an excellent idea to use it as an opportunity to create new business in your practice. But what ever you do, don't forget about what's directly under your nose - a group of existing clients, with portfolios which have suffered during tough times. These are clients who may have been hurt by the sharemarket, worried about over exposure to the property market, or sitting on excess cash and who will have an open appetite for new solutions.
Why do client portfolios need restructuring?
We have just lived through some extremely challenging times in terms of sharemarket behaviour and the future is still not clear. Good actively managed funds should always have an important role, but it's now time to take a serious look at portfolios, introduce new core recovery solutions and weed out the underperforming investments. Having suffered through a major bear market, the only positive aspect is it's now very easy to sift the wheat from the chaff in terms of good fund managers.
Even the most robust clients have lost some of their confidence in the markets and have often redeemed their investment funds. In the past, an average or underperforming fund still made money, which helped it avoid attention. Now, every investment selection made for clients comes under the microscope. It's simply not viable to keep doing things the same old way and it's time to restructure portfolios and introduce new ideas. These portfolios need to be positioned for the future, not left to wallow in the losses of the past.
What are the benefits of using protected investments to restructure clients' portfolios?
- You are adding value
- You are accumulating into a new asset class
- You are re-evaluating the client's risk appetite
- You are lowering portfolio risk & volatility
- You are increasing diversification
- You are accessing a new solution
- You are keeping up with the times, re-weighting assets and reassessing your strategy as market conditions change
Where could I be moving money away from?
The investment which provides the strongest argument for portfolio restructuring is SUPERgrow 150. The accelerated upside is an exciting innovation and a tool which positions you to take advantage of a market recovery. However, EASYgrow 85 also presents an opportunity to get cautious clients investing more of their portfolio into equities, because of the full capital protection.
To restructure, money needs to be moved from somewhere. There are a number of areas which you can consider when weighing up the options. Whether these are appropriate depends of course on the client's individual circumstances and your own view as a planner. Below we take a tour through the majority of asset classes and raise some questions:
- Under performing equity funds
Those who have been consistently below their benchmark and are sitting on losses, a recovery plan is needed.
- Index tracking funds or index hugging funds
Using structured products, the fees are lower (no management fees), the currency is perfectly hedged and more innovative risk / return structures are available
- NZ equities
Many clients have been buying individual share holdings without actively managing them and have an over exposure to NZ shares (which only represent 0.09% in the MSCI World Index). International equities have always been considered riskier, but capital protected structures, without currency risk, turn that thinking on its head. If you can move into international markets, while lowering your risk, the reasoning stacks up. Passive tracking structures are also far more suited to many retail clients
- Cash and term deposits
While they're safe, in the current interest rate environment the potential returns are nothing to write home about. It's always important that clients keep suitable cash reserves, but excess cash assets can be moved into fully protected products
- Debentures
An asset class where New Zealand investors are overweight. As these come up for maturity, a movement into protected investments will help diversify
- Property funds
Possibly another overweight class for many investors. Property has seen significant gains and calling the top is next to impossible. However re-balancing portfolios is an important investment concept, to avoid being caught by a bubble. It's important to act in advance with property, given illiquidity issues.
- Bonds
With medium to long term interest rates moving up, especially in places such as the US, global bond funds have taken a hit. The question this raises, is could it get worse and what exposure should clients have? Protected investments offer a new diversification tool
- General asset class re-weighting
As more capital protected products have now entered the New Zealand market and their availability is consistent, they will find a permanent home in portfolios. Due to the lack of products in the past, client portfolios have not had the benefit of the lower volatility this asset class creates. To create a space for these products advisers may have to undertake some general re-weightings across the board.
What is the risk profile of each product?
To look at the risk profile of a structured product, you need to consider the risk to capital if the markets decline and the risk of the issuer of the note backing up the product (Morgan Stanley, S&P rating A+).
- EASYgrow 85 - fully protected at maturity if the markets decline
- SUPERgrow 150 - protected from falls of up to 40% - if this 'safety net' is broken during the term, the protection is no longer in place
While SUPERgrow 150 is obviously riskier than the fully protected EASYgrow 85, it pays to put things in perspective. Yes, one investment is more aggressive than the other, but on a risk scale, both are fairly cautious. With 40% protection from market falls, SUPERgrow 150 is substantially less risky than a traditional equity fund. Even bond funds, which are considered more stable, are still exposed to interest rate risk and credit/default risk, and do not offer the sort of buffer SUPERgrow 150 does.
But don't be fooled into letting a risk profile dictate the type of client these products are suitable for. Unlike other asset classes capital protected investments can offer excellent upside potential, with the added benefit of lower risks. They can be appropriate for the full spectrum of clients.
Where do they fit into a portfolio? The core and satellite approach
Capital protected investments are very often a core holding - but you need to look at the combination of the underlying index (or asset), combined with the level of protection, before you automatically presume this. You can wrap protection around nearly anything that's tradable, so first check that it's a simple vanilla type index before categorising it. Investments such as SUPERgrow 150 and EASYgrow 85 are definitely very vanilla and in other markets are considered core holdings. The index (the MSCI World Index) is a well known benchmark for funds and as a passive investment, can be used as a building block at the heart of a portfolio.
At Liontamer we want to encourage investors to hold a range of assets in different classes. Our structures only form part of a well balanced portfolio. Our products are best used to build up the core of a portfolio and provide a tool for reducing the number of holdings that are fully exposed to market downside. By using our investments in this way, advisers can then allow themselves more flexibility when constructing the remainder of the portfolio. When a portfolio contains low cost, protected passive investments with no currency risk, satellite funds around the core can be selected with confidence. Good active managers who back their views can be used more widely and a greater range of specialist funds may enter the portfolio resulting in a truly diversified portfolio.
In addition, stop to think carefully about how you categorise these investments. In other markets they have become recognized as an asset class in their own right - simply because they behave like no other. The index linked returns may be an 'international equity', but the downside risks are nothing like one. If it's not yet appropriate for you to put structured products in their own asset-class, then you will need to find a home for them within 'equities' or 'bonds' - avoid lumping them into the alternative asset class box.
- Equities
While the temptation will be to class these as 'international equities', remember the risks are not the same, therefore there is far more flexibility to increase the percentage allocations.
- Bonds
For fully protected products, the downside risks are a lot like bonds - if you hold until maturity, you will get your capital back. For very cautious clients, international equities would not even appear in their portfolios. But products such as EASYgrow are widely used with cautious investors. Therefore you need to use them to replace assets which would normally fall into the bond / debenture / term deposit category.
Should I be combining SUPERgrow 150 and EASYgrow 85?
Financial advisers tend to use these products for all sorts of reasons - sometimes they are used on their own and other times in combination, for example a 50/50 split between the two products.
If your primary concern is putting in place recovery solutions, use SUPERgrow 150 on its own. Likewise, if you want to add in a tool which will perform well in a low to medium growth environment, again use SUPERgrow 150 on its own.
When you have more cautious clients who would benefit from equity exposure, but can't afford to take risks, use EASYgrow 85 alone. Likewise, if they are over-weight property, cash or debentures, again use EASYgrow 85 alone, to rebalance some of this.
When you can see a client who will benefit from both scenarios you need to decide on an appropriate split between the products. While both products are actually quite cautious, a 50/50 split will suit a large number of people. However you do need to allow for individual circumstances and favour one product over the other depending on their needs.
In what proportions should I be using them?
Structured products such as EASYgrow 85 and SUPERgrow 150, have quite different risk and reward payoffs than any other asset class. New structures such as SUPERgrow 150 are very innovative and this means they can't easily be molded to fit the traditional portfolio construction rules.
You simply can't open a text book and find anyone who will tell you "you should invest x% of a client's portfolio in structured products". Unlike financial planning exams the world over, where you diligently quote figures such as 25% of assets in international equities, or 20% of assets in bonds etc.
Structured products are capable of replacing parts of most asset classes. Some clients who have never invested in the sharemarket before may end up with well over 50% of their portfolio in fully protected products, because they've finally found a way to get some exposure. Of course, when allocations this high are involved, they should be split between a variety of different tranches.
For other clients, a planner may decide to replace 20-30% of their equity holdings with recovery type products such as SUPERgrow 150, to provide accelerated growth and a hedge against a low to medium growth environment in the markets. Other holdings would have unlimited upside potential and solutions such as EASYgrow 85 can form part of this.
In addition, you might also rebalance property holdings, debentures and cash deposits with fully protected solutions such as EASYgrow 85 to add some diversification.
Over time, by steadily adding a range of protected investments into the equation, you will build up core holdings that will result in better diversified, better balanced and better risk-adjusted portfolios. But the proportion of capital protected investments you use for each individual client could vary quite dramatically. The only rule of thumb is that common sense applies - never over commit to any one product and always make sure the portfolio as a whole is well balanced.
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