# Bank Stocks Tracker Bond from Wealth Options/Anglo Irish Bank



## Brendan Burgess (9 Jan 2008)

This is a tracker bond which "invests" in only 2 stocks - AIB and Bank of Ireland. 

You can get the PDF brochure [broken link removed]



It pays 100% of the growth in the capital value.
It guarantees 100% of the investment. It is a 6 year term. But it averages the growth over the last 18 months, so you effectively get 4 years and 9 months growth only.

You miss out on the dividends! This will probably be around 40% of the return over the next 6 years.  Let's say you lose another 5% due to the averaging for the last 18  months, and you pay a massive 45% of your investment to get a guarantee that these two bank shares will  not decline over the next 6 years. 

Is this the worst value product on the Irish market today? 



Brendan


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## Duke of Marmalade (9 Jan 2008)

Oooh! This is very difficult to assess _Boss_.

Your calculations are broadly correct - but is 45% bad value for all upside and no downside on just 2 stocks?

Good transparency, thanks to the Consumer Protection Code. Total charges are 4.8% which includes 3.0% commission. That is not a rip off over 6 years - compare it to geared property funds.

So if by bad value you mean a "rip-off", the "rip off" is happening in the hedging terms negotiated by Anglo. Anglo is not doing the ripping off but I suppose it's the same thing to the punter.

The stocks only have to grow 26% in 6 years to beat deposits.

These are usually priced off a Black Scholes style formula where by far the greatest input is the volatility of the share price. Currently that volatility is very high, which suggests maybe wrong time to buy. Also I can't see there being much depth in the wholesale market (unlike with indexes like FTSE) which would suggest that indeed the hedging price to Anglo is probably too high.

Dividends feed into these formulae and that is why, despite the high volatility, there is 100% upside (ignoring averaging) unlike participation rates like 70% on low yielding indexes.

Would you be better off investing direct and getting your divies etc.? I suppose the banking sector is haunted by the Northern Rock scare - if normal service is resumed these stocks should regain recent losses but...and it is a big but.

I won't be investing (gambling), breaks too many rules like diversification etc. but maybe not as quick to condemn as "bad value".


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## Brendan Burgess (9 Jan 2008)

It's difficult to discuss this without breaking the ban on the discussion of valuation of shares. 

So one bank is giving you a guarantee that the share prices of the two other banks are not going to fall over the next 6 years? 

Would you not be far better to put around 75% of your money in a high interest deposit and punt the rest directly on shares? 

I just don't think it's worth paying 45% for a guarantee of your capital value. 

Maybe this is not the worst tracker bond on the market. I haven't looked at other lately, but has the recent volatility made them very bad value? I would have thought that tracker bonds should be cheaper now after the market has fallen, than they were when the markets were much higher.

Brendan


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## Duke of Marmalade (9 Jan 2008)

_Boss_, I hope this doesn't turn into a dialogue, very interested in others' views.

Your alternative portfolio does seem a bit more attractive but it only gives 25% exposure to bank shares. The tracker bond gives 100% exposure to the capital performance of bank shares.

The derivatives market ignores the relative historic position of the market - it takes the current position as gospel. It is the volatility that drives prices.

The Anglo Tracker Bond is probably fairly enough priced with only a 4.8% charge over 6 years. But is it a good investment? I really can't opine on that.


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## LDFerguson (10 Jan 2008)

Hi Brendan, 

I think you're being a bit harsh on this.  


The averaging in the final 18 months has an equal chance of saving you money as losing it, depending on the direction of the share prices in that period.
Even if the share prices are going up steadily in the final 18 months, the averaging loses you half (not all) of the growth in that period.
For what it's worth, my own opinion on this would be: - 

Negatives

Locking up your money for 6 years
No participation in dividend income
Six years is arguably too long for a recovery play on these two shares
Positives

Viable alternative to leaving your money sitting on deposit for six years.  As Harchie points out above, the share price only has to increase by something like 26% over the period for this to beat a deposit account.  In my view, the target market should be the low-risk end of the market, i.e. those who would otherwise leave the cash sitting on deposit and NOT those with a higher appetite for risk who are looking for greater growth.
A simple, transparent proposition with the charges clearly outlined.



> Would you not be far better to put around 75% of your money in a high interest deposit and punt the rest directly on shares?


 
No, because you'll only get share price appreciation plus dividend income on 25% of your cash.  If we accept your assumption that dividend income over the period will be 40%, then you'll get 40% on 25% of your cash, i.e. the dividends would only add 10% to your overall investment after 6 years.  But you'll have lost out on share price appreciation on the other 75%.  

You could theoretically invest your 75% on deposit and buy a derivative with the other 25% but you'd need to be a very sophisticated investor to do so, and if you are, then you're not the target market of this product anyway.


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## F. Kruger (10 Jan 2008)

Brendan said:


> Is this the worst value product on the Irish market today? Brendan


 
It is easy to get carried away and speculate that 'there is no way that these two shares will be under after a period of 6 years'. However, there will always be that doubt in peoples minds that it may not turn out that way.

It may seem crazy to the seasoned stock picker that this bet is bad value but people will buy this for the 'guarantee'. If we trusted our banks wholeheartedly then this might not sell, but their record speaks for itself. 

Fear, uncertainty, doubt - Stick a guarantee on it and it will sell.

I don't like the fact that the 'guarantee' is underwritten by another Irish Bank.

I do like the transparency that WO included in the brochure, but then again they were never shy about this issue.

Whether it is a good investmet, only time will tell, so the jury will be out for the next six years.

_Hoss, _I presume that there is some mechanism in place on these that allows for a takeover scenario and its effect on the 'share' price within the 6 year period.?


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## Duke of Marmalade (10 Jan 2008)

A frightening thought occurs to me. If 4.8% are the sum total of the retail charges then the balance, c. 40%, is the wholesale cost of the guarantee.

In other words the big boys think that a fair price to be guaranteed that these 2 shares rise over 6 years is a whopping 40%!


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## Statler (10 Jan 2008)

"I presume that there is some mechanism in place on these that allows for a takeover scenario and its effect on the 'share' price within the 6 year period.?"

Terms & Conditions specify that a "replacement stock" will be used to maintain the number of shares at 2. The replacement stock is to have "similar characteristics" namely volatility & dividend yield and "where possible" may include market cap., liquidity, industry sector and geographic location.
Makes it difficult to know what you would get for your investment in a takeover scenario.

This is not an investment that would appeal to me personally - would rather buy the shares directly, taking the dividends and reserving the flexibility to take profits on price appreciation/ limit losses if necessary and have the invested funds readily available should I need them or see better value elsewhere.

As to whether this bond is good value or not depends very much on your perception of risk, your views on the likely performance of these 2 shares in particular (and the sector/ Irish economy generally) and if you are happy to lock up your funds for a full 6 years with a (potential) lump sum return at the end of that period.

The capital guarantee is potentially very attractive to some investors, but it ends up being expensive. 
77.94% of your investment is essentially put on deposit at c. 4.25% compounded annually with Anglo in order to give you 100% back if the shares fail to deliver. Cheap cash for Anglo in the current market.
4.8% goes in fees. Reasonable in my view and may be considered as being supplemented by inexpensive 6-year deposits at ECB +0.25%.
17.26% is therefore left to generate a return over and above the initial investment. 

I am not sure how Anglo are structuring this product, but one option would be to set up a special purpose company which enters a swap with an external counterparty. This SPC uses the 17.26% of original investment plus 4.8x this amount of debt provided by their swap counterparty in order to buy shares equivalent to 100% of the total investment. These shares are held for the 6 year term and in return for providing the debt the swap counterparty receives dividends plus/ minus the effect of the averaging over the final 18 months plus the 17.26% up front. Ignoring the averaging, which could go either way depending on market conditions at that time, and taking the 40% Brendan mentioned as the dividend income over the period plus the 17.26% contributed up front, the cost of providing the leverage and taking the risk that the value of the shares may fall is c. 10% of the borrowed amount p.a. (very approximate figure made up of 6.8% from dividend income and 3.2% p.a. from the initial contribution, compounded annually for ease of calculation).

I will not get into a discussion about these individual shares and likely dividends. However, if I was the swap counterparty 10% would not seem an unfair price to me given the lack of certainty around the dividend payment policy/ ability of any company over a 6 year period, the possibility the share could be worth less in 6 years and current conditions in the banking industry worldwide.

And my conclusion after that ramble: For somebody that regards capital security as paramount, but wants to take a punt on bank shares, it may not be a bad product. It is expensive to provide capital certainty but I don't think Anglo have charged excessively. Personally, it is not something I would invest in, but each investor is different.


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## Duke of Marmalade (10 Jan 2008)

_Statler_, you beat me to it, I was also going to draw the analogy with a geared investment in the shares, but you did it much more succinctly than I could have achieved.

I would agree that the effective cost of the borrowing is c.10%. This would be expensive for normal full recourse borrowing, but this is non-recourse. 

However, we are not offered the stand alone geared investment we have to also supply the deposit so the underlying borrowing costs should be about 4.25% leaving about 6% per annum as the cost of the non-recourse insurance.

The shares would have to fall by about 50% over the 6 years for this insurance to be "in the money". Make your own call.


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## Statler (10 Jan 2008)

"The shares would have fall by about 50% over the 6 years for this insurance to be "in the money"." 

That assumes dividends are as expected for the full period, underperformance in earnings/ dividends would likely be accompanied by a lower share price resulting in a double hit. 

I'm certainly not saying that whoever is providing the insurance will not make a profit, but considering duration/ cover for 2 banks in Ireland etc. the cost may not be excessive in the current market.


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## Duke of Marmalade (10 Jan 2008)

On a different tack, I want to suggest two propositions:

A. 100K lump sum investment, capital guaranteed, interest payable after 6 years - the capital upside (if any) on XYZ (shares, index, whatever)

B. 4.25K p.a. regular savings plan, maturity proceeds - the capital upside on XYZ

A. is of course your classic Tracker Bond, and as Fergie points out, is generally regarded as a low risk type of investment.

B. would be regarded as a very high risk investment, even gambling.

But they are essentially the same proposition. The conundrum is that people are much less willing to risk their capital than their interest. It is almost as if they regard interest as some sort of windfall. Throw in the inflation factor and the conundrum becomes even more stark.


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## Statler (11 Jan 2008)

There is little doubt that people have different appetites for risk depending on whether they are considering what they currently have or the future value - the existence of capital guaranteed products is an illustration of this. Adding the guarantee adds complexity and cost, however this cost is not always quantified by potential investors that may view it as allowing them take a punt on an asset/ investment that would otherwise be outside their risk appetite or comfort zone. 

Perhaps it would be useful to look at this by comparison with a simplified alternative, namely direct investment in the 2 shares concerned of 100% of capital (rather than the 75%/25% deposit/ share approach mentioned above). 

Somebody buying the 2 shares could sustain a loss on the value of the shares of up to 14.8% at the end of year 1 and then put the remaining balance of their investment on deposit with Anglo for the following 5 years and still finish the 6 year period with the same amount of capital. For the end of year 2 the figure is 15.6%, year 3 is 16.5%, year 4 is 16.8% and year 5 is 17.2%. Switching to a fixed term deposit after a certain level of loss is reached on the shares would ensure the investor would not suffer a capital loss over the period, while direct participation in the shares obviously offers full exposure to the shares (and a greater potential gain incl. dividends) and greater flexibility.

Figures are pretty quick and dirty, based on these assumptions: 
1% stamp duty and 1% per trade gives a total cost of 5% to get in and out.
4.45% (5-year rate in Best Buys) is available on deposits with Anglo throughout the period.
Dividends paid flat over the period.
Individual paying tax at the top rate.


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## Duke of Marmalade (11 Jan 2008)

_Statler_, struggling with your figures, for example why is the round trip 5%? I though 3% - 1% stamp, 1% in, 1% out?

Interesting strategy though. Isn't this a ringer for spread betting? Round trip .5% plus .5% per quarter that it is held, but divies only "taxed" at an effective rate of 20%.


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## Brendan Burgess (14 Jan 2008)

Take a bow lads. You got a mention in yesterday's [broken link removed]

[FONT=Verdana, Arial, Helvetica, sans-serif]
*Investments*
There is an interesting debate raging on Askaboutmoney.com following the launch of a bank stocks bond promoted by Wealth Options.

The bond invests in two stocks, AIB and Bank of Ireland. It offers a 100 per cent capital security at maturity plus 100 per cent of any increase in the value of the weighted basket of the two stocks over the six-year period.

The capital security guarantee is provided by Anglo Irish Bank. The charges amount to 4.8 per cent, of which 1.8 per cent goes to Wealth Options and 3 per cent to the investment intermediary.

Askaboutmoney founder Brendan Burgess is sceptical about the product, asking if it is ‘‘the worst value product on the Irish market today’’. He doesn’t like it because investors aren’t offered the dividends paid by the banks over the period and because, he says, you pay a massive 45 per cent of your investment to get a guarantee that these two bank shares won’t fall over the next six years.

Not all his online respondents were as sceptical as Burgess, with many recognising that the guarantee element appeals to the risk averse. One thing is sure, though: the layman has little chance in assessing whether the pricing of the guarantee represents good value. That might be one for the Society of Actuaries to get its teeth into.[/FONT]


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## ClubMan (14 Jan 2008)

Brendan said:


> [FONT=Verdana, Arial, Helvetica, sans-serif]One thing is sure, though: the layman has little chance in assessing whether the pricing of the guarantee represents good value. That might be one for the Society of Actuaries to get its teeth into.[/FONT]


A bit like this thread. I'm afraid you lost me soon after the first post anyway...


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## Duke of Marmalade (15 Jan 2008)

Brendan said:


> Take a bow lads. You got a mention in yesterday's [broken link removed]


 
Good stuff, _Boss_. BTW how do you know _Statler_ is a lad, or are you simply not including him/her in your invite?


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## Statler (15 Jan 2008)

Harchibald,

Round trip should indeed be 3% - wrong figure included in my calculation and then put directly into my post. Loss amounts before transfer to a deposit should therefore be higher. 

The figures are very rough (might try a proper calculation when I have enough time), but are just an attempt to put the bank stocks tracker and the guarantee into perspective. Spread betting would also be an interesting alternative, but one I think an investor that would favour a capital guaranteed tracker over direct investment is unlikely to contemplate. 


"One thing is sure, though: the layman has little chance in assessing whether the pricing of the guarantee represents good value. That might be one for the Society of Actuaries to get its teeth into."

I'll get my coat.


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