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Comparing index trackers with GEBs tells us absolutely nothing

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Comparing index trackers with guaranteed equity bonds is like comparing elephants with giraffes. What does it tell us? Nothing, other than they are two very different beasts.

The IMA’s choice for comparison is an interesting one. GEBs are indeed a form of structured product, but they are not the most widely available investment, nor are they in any way representative of the structured product market as a whole. By highlighting the performance of National Savings & Investments GEBs, the IMA has also – and this is crucial – elected to compare trackers with products backed by the government. These are, in other words, very low-risk, low-return products (technically deposits) with a state guarantee. Not the most obvious choice for comparison with a pure equity investment in which investors’ capital is 100 per cent at risk.

The key problem, of course, is that the contrast makes no allowance for investors’ appetite for risk. These are in no way, shape or form products that would share the same space in a comparison website. The question, therefore, is: what would make a fair comparison with trackers? More meaningful would be capital-at-risk structured products in which participation to an index is geared. Typically, geared products have a protection barrier under which capital becomes at risk; in the event of a breach, investors simply receive the index performance, without dividends. The idea of a product like, say a supertracker – which is a geared play on the FTSE 100 - is that by giving up dividends investors hope to gain greater capital growth.

These particular products now have been maturing in good numbers for the past five years and to the best of my knowledge have produced good returns.  In more detail, Barclays Wealth alone has seen nine maturities of the supertracker product. Five of these have outperformed the FTSE total return index; but that does not take into account UK tracker fees, which the IMA estimates at 1.05 per cent (fee taken as average TER). Add in trading and stamp duty costs and the average TER for UK trackers rises to 1.12 per cent, according to the IMA. Include these costs, and six out of our nine maturities have outperformed the average UK tracker fund, while relative performance is better across the board. Add in the cost of advice and the picture would undoubtedly improve again. Either way, what these maturities show is that the enhanced upside potential of a structured product with a similar risk profile to a tracker more than makes up for the dividends forsaken by the investor. And that neatly illustrates a wider point.

By using a tracker fund as a basis for comparison, the IMA’s research should – but doesn’t – take as its starting point capital being at risk. Instead, it starts at a point of no risk to capital (GEBs) and, from this highly advantageous position, it criticises the performance of a product that was never meant to compete with a pure, unprotected equity investment. As a result, the IMA’s research is as insightful as observing that a tank is slower than a motorbike.

To make this is a more constructive exercise – now and in the future – we should ensure any discussion starts with a capital at risk product and proceeds on that basis. Trackers - simple, easy-to-understand products, where the risks are clear – are as good a place to start as any. All we ask is that the subsequent comparison is like-for-like – i.e. the investments involved share a similar risk profile. Comparing a tracker with a geared product like our Supertracker makes sense as, broadly speaking, both products occupy the same place on the risk spectrum. But where there is additional protection to capital, we should take care to shift the product further to the left of the tracker, to reflect the fall in risk and corresponding decline in performance expectations.

The last word on this subject should go the regulator. One of the many FSA documents on structured products states that: “Advisers need to consider these [structured product] features to ensure they recommend a suitable product taking account of the customer’s risk profile, investment objectives and financial needs and circumstances.” Surely this should apply across the board when considering any investment?

Colin Dickie is head of UK retail, investor solutions, at Barclays Capital

 

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Readers' comments (5)

  • Of course, what you get with the structured products, which you don't get with proper trackers (i.e. which buy the whole market), is counter-party risk. Think Lehmans and AIG.This is un-predictable but can result in a total wipe-out scenario which, in the real world is highly unlikely to occur with trackers. The credible trackers, have TERs in the range 0.3%, not 1.12% with pretty low tracking error and full participation in dividend income. This is not to be sniffed at since income can constitute quite a bit of the return.

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  • Couldn't agree more Colin. Let's be sensible and compare eggs with eggs.

    @ Chris, the dividend argument against structured products simply is not true, since the higher the dividends forgone by buying a structured product and not a direct investment, the cheaper the derivative to buy and therefore the higher the synthetic coupon or upside gearing can be offered in the structured product. It all washes out.

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  • I am one of the 5620 UK savers who lost 100% of their investment when the counterparty (Lehman) failed in 2008. This scenario was repeated world-wide, with tens of thousands of affected structured product holders in Hong Kong, Australia and the US still protesting. In retrospect, now that I understand the potential consequence of couterparty failure first hand, I would never put my money into something with this kind of vulnerability, no matter how small the likelihood of counterparty failure.

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  • Can't see a problem with comparing elephants and giraffes. Surely we do this all the time - comparing equity with cash for example.

    Trying to say one is better than the other or looking at past performance is, if course, complete nonsense. Out of context anything can be shown to be true.

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  • @missold if you have absolutely no appetite for loss of capital then you should not invest at all. Put your money into a bank account below the FSCS £85k limit. The downside of course is that this "risk free" strategy also has risk, inflation risk. If you want to have the potential to earn more than 3% then you need to take some risk. This is investing 101. In the case of capital protected structured products this is the risk that the bank will default. The level of risk is still far less than putting your money into shares or funds. Structured products offer a natural way for investors to earn a reasonable return (6 - 8%) without taking on the full risk associated with shares. You just need to understand they arent risk free. If they were, why would they pay more than putting your money in a bank account? Google "SPGO" if you want to see what the latest products have to offer.

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