Incredible underperformance of a structured product

[Duke of Marmalade]

• Can BNP Paribas explain the massive UNDERPERFORMANCE of the SEDV Index (which they devised) between 2019 and 2024 (MINUS 9.1% a year against its benchmark, the EuroStoxx50) AND its massive OUTPERFORMANCE between 2001 and 2019 (PLUS 4.5% a year against the same index)?

I have been out of the game for some time now but according to Colm this beauty has swung round by over 13% p.a. versus its benchmark in the wrong direction. And not just over a year or two but between 15 years of what Colm calls "simulated" performance and 4 years of actual performance. That seems incredible from my experience.
It seems a pretty complicated beast even as structured products go and Colm goes into more background as follows. (Colm gives a rather more colourful metaphor for the product construction in his LinkedIn post, which I recommend that you treat yourself to )

[*]This is about the Solactive European Deep Value Index (SEDV Index for short), which BNP Paribas, a world-leading French bank, devised and marketed. Index values are calculated by Solactive, a German full-service index provider. The index of 50 European stocks has the very unique feature that it is rebalanced every month to ensure that up to 25 of them are stocks expected to pay a dividend in the coming month. BNP Paribas stated that the EuroStoxx50 was its benchmark.

In the 18 years 2001 to 2019, the SEDV Index OUTPERFORMED the EuroStoxx50 by an average of 4.5% a year, cumulatively over 120%. BNP Paribas only launched the SEDV Index in July 2015, so performance in its first 14 years was simulated, not real.

A fellow actuary and I studied the rules for the SEDV Index in August 2019 and concluded that it was likely to UNDERPERFORM the EuroStoxx50 significantly in future. Subsequent underperformance was far, far worse than we expected. Between 6 September 2019 and 1 January 2024, it UNDERPERFORMED its benchmark, the EuroStoxx50, by an average of 9.1% a year, a cumulative 41.7%. (The underperformance is so massive that I fear I may have made an arithmetical mistake. Could BNP Paribas please check if my calculations are correct?).

Why does this matter? It matters because the performance of the SEDV Index determines pay-outs on a five-year investment product called the Secure Accelerator Bond 4, which was sold in 2019 to retail investors. MMPI Ltd, trading as Broker Solutions, was the lead product distributor in Ireland.

Investors will get their money back plus a 40% bonus when the product matures in September 2024, PROVIDED THAT the SEDV Index at that date is at or above its level on 6 September 2019. If it’s below it, they will lose the percentage fall in the SEDV Index, to a maximum loss of 15%.

If the product were to mature on 1 January 2024 and if it was linked to its benchmark EuroStoxx50, investors would get their money back plus a 40% bonus, with room to spare. The EuroStoxx50 Index at that date was 129% of its September 2019 when 100% would have been enough for the 40% bonus. But the product is not linked to the EuroStoxx50. It is linked to the SEDV Index. The SEDV Index fell more than 12% between 1 September 2019 and 1 January 2024, so investors would have lost over 12% of their investment if the product had matured on 1 January 2024.

We wrote to the CBI (Central Bank of Ireland) in August 2019, before the product was launched, warning that the SEDV Index was likely to underperform its benchmark. We also warned of deficiencies in back-tests in the brochure (the responsibility of Broker Solutions) . Despite our warnings, the product launch went ahead, with no changes to the wording of the brochure.

It is now likely is that everyone who bought the Secure Accelerator Bond 4 will suffer a significant loss, when they could have comfortably expected a 40% bonus if it had been linked instead to its stated benchmark, the EuroStoxx50.

 

[Monksfield]

I would have thought that if the brochure or any marketing literature holds out that the return was linked to the EuroStoxx 50 (as opposed to a hugely bastardised version of it) the parties who promoted it are well in the firing line. This would be particularly so for any investment advisors who had not properly understood and explained to clients just how different the SEDV index is from EurStoxx50.

The use of this type of 'adjusted' index which has an inbuilt and substantial downward pull on outcomes should not be permitted by the Central Bank. Consumers simply cannot understand how hugely they load the dice against them, and that is even where the back-testing is fair. If the Central Bank had the detail of this product explained to them before it was launched, shame on them.

 

[Fortune]

The index of 50 European stocks has the very unique feature that it is rebalanced every month to ensure that up to 25 of them are stocks expected to pay a dividend in the coming month.

Why would anyone want that?

 

[Colm Fagan]

I would have thought that if the brochure or any marketing literature holds out that the return was linked to the EuroStoxx 50 (as opposed to a hugely bastardised version of it) the parties who promoted it are well in the firing line.

Hi @Monksfield I agree. As I wrote on LinkedIn this morning, though, in reply to others who took a similar harsh line on brokers who sold the product, I can see how people were tempted by an index which outperformed its benchmark by a phenomenal 4.5% a year over 18 years, especially when they saw that it was devised by a world-leading bank, which they would be inclined to trust. I definitely would not expect it to underperform the same benchmark by over 9% a year for the next four years.
What I can't understand is how the media and regulators seem unconcerned about this revelation.
If I was the official in Brussels or wherever responsible for supervising the bank in question, I would call in its bosses and ask them to tell the reasons for the incredible outperformance relative to its benchmark (defined as such by the bank itself) when there was nothing riding on it, then for it to underperform even more incredibly when millions in ordinary savers' money was riding on it. If they couldn't give satisfactory answers, I would threaten to revoke their licence, on the basis that they couldn't be trusted. Trust is at the heart of banking.

 

[Duke of Marmalade]

Why would anyone want that?

Good question. Here is the answer provided by the sponsor of the Index.

A dividend paid is a positive signal sent to the shareholder: it is likely to increase their trust towards the company

Option prices are negatively correlated to dividends: the higher the dividend paid, the lower the underlying price, and the lower
its option price

 

[Brendan Burgess]

Fair play to you Colm.

You actually predicted this

Diary of a Private Investor - structured product too good to be true

Too good to be true Colm Fagan Diary of a Private Investor Update 17 10 September 2019 A conversation with my friend Brian Woods almost four weeks ago started it all. “Colm, I found an investment you might like. It’s called Accelerator Bond 4. Google it and see...

www.askaboutmoney.com

 

[Duke of Marmalade]

Fair play to you Colm.

You actually predicted this

Diary of a Private Investor - structured product too good to be true

Too good to be true Colm Fagan Diary of a Private Investor Update 17 10 September 2019 A conversation with my friend Brian Woods almost four weeks ago started it all. “Colm, I found an investment you might like. It’s called Accelerator Bond 4. Google it and see...

www.askaboutmoney.com

Brilliant Boss! This sentence is uncanny.

“Are you sure, Colm? That’s a drag of almost 20% over five years. Putting it another way, are you saying that, if the EURO STOXX 50 Index increases by 20% over the next five years, the Solactive Index could still show a loss?”

 

[AJAM]

In investing, "you get what you don't pay for".

Anything that is complicated has high fees.
Anything with high fees will have poor performance after fees.

Stay away from high fees and complex products.

 

[Colm Fagan]

Fair play to you Colm.

You actually predicted this

Thanks Brendan, but it's depressing that here we are, over four years later, and still nothing has been done about that index. I can't believe that one of the world's leading banks can devise an index that beats its benchmark by 4.5% a year on average for 18 years, when no-one made money from the outperformance, then it underperformed it by an incredible** 9.1% a year for over four years, when lots of people lost, or look like losing, lots of money, yet no-one is holding them to account. Where are the media, the regulators, even the courts, to force them to explain the contrasting results? Of course, some of the other points made in the discussion, such as @AJAM 's comment about high fees and complex products, matter, but they pale in comparison.

** The level of underperformance is so huge, I thought I may have made an arithmetical error, so I checked my numbers again and again, and asked Brian Woods to check them. We couldn't find a mistake. I also asked (through LinkedIn) for someone from BNP Paribas to provide the correct figure if I was wrong, I heard nothing.