The balance appears to be shifting towards the middle way between cash deposits and unprotected equities, driven partly by negative real cash returns and partly by equity market falls. It is time, we think, to consider the role of protected investments in all market conditions and for all investor risk profiles.
We believe that modern portfolio construction has a place for protected investments as a fundamental long-term rolling holding for cash-plus investors through to higher risk categories.
The essential point is that portfolio construction is about risk management as much as absolute or relative performance. Investors are simply more outcome focussed than conventional portfolios recognise. This will have become even more apparent to advisers carrying out client reviews and finding that theoretical risk appetite does not equate to a sanguine acceptance of significant falls in capital.
Most investors see their portfolios as a means to an end – a vehicle to allow them to live the life they wish in the future. To borrow from pensions language most clients would prefer a defined benefit-based portfolio and, whilst this is technically becoming less feasible even for most pension schemes, protected investments can play a part in helping clients build more predictability into their finances. Of course diversification of asset class is theoretically a key plank of risk management, but the downturn – during which equities, gilts and property have moved broadly in line with one another – has revealed this to be a flawed method of risk mitigation.
By contrast structured products offer predictability in the context of potential returns with varied margins of safety, right up to full capital protection. Even when cash returns are high the “cash-plus” investor can find structured products with materially higher returns for low or defined risk levels.
And the more risk-orientated investor can find structures offering geared access to more esoteric sectors; or alternatively can embed his or her core portfolio with a broad range of protected products, effectively giving that portfolio permission to seek the highest returns for the balance of the capital. Indeed this strategy – safety-first core holdings in more efficient markets and satellite forays into areas where genuine outperformance is more feasible – is an accepted route in the institutional sector.
Some commentators point to the performance of unprotected equities in some markets; for some sectors; for some funds; for some managers; and, of course, when these strategies go well they will outperform any structured product. But the hoary question of identifying predictable long-term outperformance raises its head. And the reality is that investors only buy once the performance of the market, sector, fund or manager has been well demonstrated. This reality means that headline performance figures massively overstate the mean yield experienced by clients. Deploying protected investments as core holdings in all conditions – and not only in extended bear markets – should therefore have a positive effect on the returns clients actually experience.
Finally, just one comment on the question of how to select the right structured product provider. We suggest three key criteria (product terms notwithstanding): consistency of offer; transparency of terms; and strength of counterparty.