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

jpd

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Surely all financial products are designed to produce a profit for the producers - otherwise, why would they bother?

The problem is making them understandable to the potential purchaser. If they are so complicated that the purchaser has no chance of understanding what is being sold, then they should walk away.
 

Duke of Marmalade

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And who sells these products to the public Steven ?

I am sure you don't, but many financial advisors do. And it is difficult for members of the public to know what type of FA they are dealing with. One that sells perfectly legal products which are designed to profit their promoters, or one who would not do such a thing.
Maybe even the FAs are being duped or at worst engaging in wishful thinking. Certainly some of the backtesting illustrations are very seductive. A product that is shown to backtest successfully, providing 40%+, in 1,304 times out of 1,304, must be a winner even if that is a very flattering backtest. Even I, when I first saw this one knew to dismiss the backtesting results but I argued with myself that surely any self respecting index would have at least a 50% chance of being above its initial level in 5 years. But the reality is that this weirdly contrived index would appear to have a less than 20% chance of achieving that humble goal of being above water in 5 years.
 

WhiteCoat

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Colm/Duke,

Sorry if I'm being a bit slow on the draw here. I haven't looked that closely at the minutiae or perhaps picked up the detail in your posts correctly and wasn't aware of the average XD stocks being 25% rather than 50%, etc., etc.

Before I get into it - Duke, is 7.2% a typo?

Anyway let me try again please! I accept that I might be wrong - I'm just trying to figure out where (think dog with a bone). Thanks for your continued forbearance.

1. This silly index (SI) is made of stocks that have DYield of X% (Please tell me what X is)

2. Let's take it that dividends are paid twice yearly

3. On average, in each month, 25% of the stocks will be XD. (Could this be due to the clustering of dividends that Colm spoke about, i.e. close to 50% some months and close to 0% other months?)

4. On average and very crudely, etc. does it not follow that:
(a) The total monthly dividend would be X%, divided by 2 (because dividends are paid half-yearly) and then divided by 4 (because of the 25%). In simple terms, X%/8

(b) Wouldn't this X%/8 need to be multiplied by 12 to arrive at the annual impact? So, for example, if the DY of the stocks within SI is 4%, the annual impact would be c. 6%?
 

Duke of Marmalade

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Colm/Duke,

Sorry if I'm being a bit slow on the draw here. I haven't looked that closely at the minutiae or perhaps picked up the detail in your posts correctly and wasn't aware of the average XD stocks being 25% rather than 50%, etc., etc.

Before I get into it - Duke, is 7.2% a typo?
12 x 0.9 = 10.8. I think my calculator was running low in battery:oops:

Anyway let me try again please! I accept that I might be wrong - I'm just trying to figure out where (think dog with a bone). Thanks for your continued forbearance.

1. This silly index (SI) is made of stocks that have DYield of X% (Please tell me what X is)
Colm estimates 4.7%.

2. Let's take it that dividends are paid twice yearly

3. On average, in each month, 25% of the stocks will be XD. (Could this be due to the clustering of dividends that Colm spoke about, i.e. close to 50% some months and close to 0% other months?)
Yes, they allow themselves up to 50% but there are months when there simply aren't that many available.

4. On average and very crudely, etc. does it not follow that:
(a) The total monthly dividend would be X%, divided by 2 (because dividends are paid half-yearly) and then divided by 4 (because of the 25%). In simple terms, X%/8

(b) Wouldn't this X%/8 need to be multiplied by 12 to arrive at the annual impact? So, for example, if the DY of the stocks within SI is 4%, the annual impact would be c. 6%?
That is all correct. And with Colm's 4.7% estimate that would give 7.1%. But the benchmark is itself a price only index and so suffers a drag versus a total return index of its dividend yield, which Colm reckons is 3.5% hence the relative drag versus its benchmark is 3.6%.
 

WhiteCoat

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Duke - I need to spend another penny (I'm of that age, alas - hopefully nothing sinister.....). [My wife just asked me what I was doing "It's Friday night, dear" - "Oh just some lab reports, pet"...….if she knew the time I was spending on this and other similar stuff, she'd have been sectioned or worse! Men are truly from Mars.]

*********

I understand, I think, BNP's bet from the perspective you so ably set out in post #7 of his thread.

When you get the chance, I'd like to understand the mathematical merits of this bet PLEASE! (i.e. I don't, for a second, wish to take your time for granted.)

This is what I understand so far. If the total return, including dividends, of the stocks that are included in the Silly Index, is greater than c. 7.1% p.a. (on average) over the next 5 years, then the bet pays out.

So the question is - is this a 1 in 5 to 1 in 6 chance as described previously or is it better or worse than that? (I guess we are getting into expected returns, SDs and all that good stuff - but I'll happily be guided by you!). In this way, we'll be able to establish better the merits of this bet from the punter's perspective?!
 
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Duke of Marmalade

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This is what I understand so far. If the total return, including dividends, of the stocks that are included in the Silly Index, is greater than c. 7.1% p.a. (on average) over the next 5 years, then the bet pays out.

So the question is - is this a 1 in 5 to 1 in 6 chance as described previously or is it better or worse than that? (I guess we are getting into expected returns, SDs and all that good stuff - but I'll happily be guided by you!). In this way, we'll be able to establish better the merits of this bet from the punter's perspective?!
Yes that is the deal. You and I have no way of knowing the odds but if Paribas are pricing rationally their quants must reckon the chances of this are of the order of the throw of a 6 with a dice. Certainly not 1304 chances out of 1304!
 

WhiteCoat

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Duke,

The essence of this thread is that the SI structured fund represents really terrible value - to the extent that it's reportable, etc. (as in how could BNP seek to be reputable whilst peddling such merde, etc.). The product may, indeed, be merde……..but only if the odds are poor! If the odds are better than 1 in 5ish, then the odds may not be / are not, poor - especially so given the risk free (or least risk, if you will) alternative. By extension, certainly not reportable?

That was the driver of my question, respectfully posed.

Thinking about this again, are we sure that the drag from total returns of stocks that make up the SI is not c. 11.8% (7.1% + 4.7%)?
 
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Duke of Marmalade

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Duke,

The essence of this thread is that the SI structured fund represents really terrible value - to the extent that it's reportable, etc. (as in how could BNP seek to be reputable whilst peddling such merde, etc.). The product may, indeed, be merde……..but only if the odds are poor! If the odds are better than 1 in 5ish, then the odds may not be / are not, poor - especially so given the risk free (or least risk, if you will) alternative. By extension, certainly not reportable?

That was the driver of my question, respectfully posed.

Thinking about this again, are we sure that the drag from total returns of stocks that make up the SI is not c. 11.8% (7.1% + 4.7%)?
The original version of this post was the weirdest put down I have ever received after nearly two and a half thousand posts on this blog. I thought we were having a constructive engagement until then. Completely out of left field. I can only assume that you were tired and emotional in the wee hours of a Saturday morning.
 
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WhiteCoat

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You're right, Duke - I should not have written what I did. I just was frustrated with what I perceived was a response which did not address the question.
 

Duke of Marmalade

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You're right, Duke - I should not have written what I did. I just was frustrated with what I perceived was a response which did not address the question.
Ok forgiven.;)
I had arrived at the place you had arrived. I asked myself "what are the actual odds?" As I said I am not nearly close enough to the market to assess those odds independently. But I presume that Paribas are pricing rationally. They would not run a naked position on the option. They would dynamically hedge it and thus crystallize the market's assessment of the odds. For example, say the odds are in fact even money so that the option is worth 30%. By hedging the option, 30% would in fact turn out to be the cost to Paribas and since they got at most 10% from the punter they would ensure a certain loss of 20%. I hope you are not making the rather metaphysical point that even the market might have these odds hopelessly wrong.
People have likely invested millions in this product, having been led to believe that the chances that they will not get 40% or more are less that 1 in 1,304. That is not a trivial matter.
 

cremeegg

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I asked myself "what are the actual odds?"
Would a financial advisor selling this product not have the answer at his/her fingertips. And more pertinently, if not why not.

BNP must calculate the odds.

Anyone retailing a product could be expected to ask the manufacturer what the contents are, and share that with the public.

The take away for me from this thread is not; "structured products are bad value", I mean so what, lots of things from BMWs to Jam Doughnuts are bad value; No the lesson for me is that the lack of transparency in the financial services industry is such that the whole thing is unethical.

The general public of pool of potential buyers does not understand these products. For a small group of well educated people with the time and the interest to unravel one product is great in that it may alert some others to the issue, but perhaps it distracts from the problem.
 

Duke of Marmalade

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Exactly cremeegg it is the total knowledge asymmetry between customer and provider that is at issue here. If the product under discussion was fairly presented in marketing material (maybe with an acceptable level of hyperbole) I wouldn't bother talking about it. It would have no takers.
 

Colm Fagan

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The product may, indeed, be merde……..but only if the odds are poor! If the odds are better than 1 in 5ish, then the odds may not be / are not, poor - especially so given the risk free (or least risk, if you will) alternative. By extension, certainly not reportable?
I do not enjoy the cover of anonymity, so I must be very careful what I say or write, but it’s important to document what we do know about this product and why we believed that we had to take action in the public interest.

Brian Woods came to me after a broker had shown him the product, saying that he was thinking of offering it to his clients. Brian thought it looked good, if the Index was kosher, and even suggested that I might like a piece of the action for my own pension fund. He asked me to have a look at the index.

At that point, Brian’s main beef was with the 1,304/1,304 “successful” back-tests, derived from experience between July 2009 and July 2019. As I joked, they could have shown a success rate of more than 15,000/15,000 by assuming bonds were issued every half-hour rather than every day, which is how the 1,304/1,304 was derived. There were only two independent five-year periods in that time - July 09 to July 14 and July 14 to July 19 - not 1,304, so the past success rate was 2/2. Even a 2/2 success rate is misleading: the last ten years have been good for shares (as commentators on my investment performance keep reminding me – quite rightly).

Neither Brian nor I had ever come across the index against which returns on the product would be determined, but we were impressed by the apparently superior stock-picking expertise of BNP Paribas and the invocation of gurus like Benjamin Graham and Warren Buffett.

We were particularly impressed by simulated past performance since 2001. Over the 18 years 2001 to 2019, the Solactive Index showed an average return of +2.82% pa while the well-recognised EURO STOXX 50 showed an average decline of -1.64% pa over the same period. Who could argue with that?

Warning bells rang when I read the bit in the brochure about selecting stocks that were due to go ex-dividend within the next month. Most ordinary investors – and probably most financial advisers – would not have realised the significance of this statement. I estimated that this, plus the higher dividend yield, meant that the expected return on the Solactive Index would lag the EURO STOXX by around 3.5% a year - a far cry from the rosy picture in the MMPI brochure and in BNP’s sales literature for the Solactive Index.

My conclusion on expected underperformance of the Solactive Index was supported by analysis of actual returns between 2017 and 2019. Based on figures supplied by BNP Paribas, the Solactive Index underperformed the EURO STOXX 50 by 3.1% a year in the 23 months between July 2017 and June 2019, close to my expected 3.5% annual underperformance.

I realise that I’m putting something in the public domain for the world to read and draw inferences from, but I cannot understand how a prestigious bank like BNP Paribas could have decided to produce a brochure in 2019 extolling the long-term outperformance of the Solactive Index, even though they must have known of its expected future underperformance and of its actual underperformance in the previous two years, both completely contrary to the message implicit in the brochure. I’m not an expert on the legalities of what you can and can’t say legally, but it’s very clear to me what that is. I believe it must be stopped.
 

Duke of Marmalade

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Well, well, well! From the folk who brought you Accelerator Bond 4 we have Accelerator Bond (you guessed it) 5 :rolleyes:
Same deal, if index is in any way above its initial level in 5 years you get 40% or more. Except the downside which was capped at 15% is now capped at 16%. But who cares! Didn't they backtest Acc 4 1,304 times, and every one produced a 40%+ gain (see page 11 of attachment). Not very surprising though when you think that the backtesting started in 2009 when the market was on its knees - hey anything would backtest well over that period!
But what's this? Have they been reading Colm's diary? They have backtested Acc 5 2,609 times, going back 15 years to 2004. And lo and behold, the punters would have suffered a loss on 830 occasions:eek: (see photo of page 11 as attachment)
Okay, better late than never but what about the poor suckers who bought Acc 4 (1,2,3???) thinking the chances of losing money were less than 1 in 1,304?
 

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Colm Fagan

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Will the back-tests eventually get to a 1 in 6 success rate, which Brian Woods and I reckon is the real chance of this product yielding a profit?

Obviously brokers like it, if we're seeing another encore, after 1, 2 and 3. By the way, I would love to see brochures for 1, 2 or 3. Let me know if anyone out there has one they can share.
 

MugsGame

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Hours of fun:
I'm chuckling at this statement in some of the brochures and guides:
In order to achieve a good price efficiency, the Index selects stocks with a low volatility and that are expected to pay a dividend in the coming month.

Is this really a Solactive product marketed and resold by BNP? It appears that Solactive conceived and operate the index, and possibly also the options supporting the bond pricing.
 
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Colm Fagan

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Thanks! They really are bringing them out thick and fast. Number 2 was only in February of this year. I was hoping it might be further back so that we could compare and contrast.

BNP are very careful to keep their noses as clean as possible as far as the product is concerned. See page 4, where it says that BNP Paribas accept no responsibility for the content of the brochure, etc. As far as I can see, though, they're the geniuses behind the magical Solactive Index. Solactive are simply number-crunchers, doing whatever BNP Paribas ask them to do.
 

SBarrett

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Thanks! They really are bringing them out thick and fast. Number 2 was only in February of this year.
Of course they are. Deposit rates are on the floor and there's all that cash on deposit that they can target from unassuming victims...ahem, investors ;)
 

Duke of Marmalade

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Hours of fun:
I'm chuckling at this statement in some of the brochures and guides:
In order to achieve a good price efficiency, the Index selects stocks with a low volatility and that are expected to pay a dividend in the coming month.

Is this really a Solactive product marketed and resold by BNP? It appears that Solactive conceived and operate the index, and possibly also the options supporting the bond pricing.
OMG so they all touted that 0 out of 1,304 lost money and now thanks to Colm, they tell us 830 out of 2,609 would have lost money and even that is a misrepresentation as the pricing indicates over 80% would show a loss.
 
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