Direct Investments Multi-Asset Solution Series 1

[LDFerguson]

Although I'm not a fan of most tracker bonds and structured deposits, this one, launched recently by [broken link removed], has a couple of unique design and marketing features. Direct Investments is run by Vincent Digby, also of www.impartial.ie.



Basic features: -

• 5 year investment term
• Minimum €25,000
• No withdrawals during term
• 100% capital protection at maturity, by way of a deposit provided by KBC Bank Ireland

Performance linked to three indices, at exactly 1/3 each: -

• Equities - EURO STOXX 50,
• Property FTSE EPRA/NAREIT Developed Europe,
• Commodities - Dow Jones-UBS Commodity 3 Month Forward

Participation is 150% of the index returns, with a maximum performance of 35%.

Unique features: -

• Internal charges on the product are capped at a maximum of 2.5% of the investment for the full 5 year term. This is a lot better than other tracker bonds and structured deposits, where the internal charges can be up to 9% and sometimes more.
• Direct Investments will arrange the product on an execution-only basis if you approach them...er...directly. If you need advice, Direct Investments will only accept business from fee-based advisors. If you approach DI about this product and need advice, DI will direct you to a fee-based advisor, who will look at your financial circumstances and might possibly advise that this product is unsuitable for you. DI have no problem with this, as they don't want the product bought by unsuitable customers. It's a laudable approach.

I like the simplicity of the product - cap on returns relates to the total basket and not just one index. Usual downsides of the genre apply - money locked up for five years and dividend income is not included.

In the end of the day, tracker bonds and structured deposits are hugely popular in Ireland at the moment - €94.3M sold in April 2012 alone. Although only suitable for a certain group of investors, I do think this is one of the better ones I've seen.

What do others think?

 

[Brendan Burgess]

I don't like tracker bonds either and I reckon the guys selling them are getting a better deal than the guys buying them.


This pay a maximum return of 35% or 6% a year compound

You can put cash on deposit with EBS for 5 years at 3.5% which compounds to around 19%.

So you are getting a potential extra 16% for risking a definite 19%. This seems a fair bargain. Probably better than the other trackers.

The problem I have is that when I investigate the small print of trackers, there is often some other restriction, the significance of which I had not appreciated. I have not read the documentation on this, so I don't know if there are any return-busting terms and conditions.

What is the significance of the internal charges? Who pays them? If I invest €100 and these indices rise by 30% over 5 years, will I not get back €135?

The world's outlook is too uncertain to be putting money away for 5 years. But if someone wants to invest in a tracker, this might be an ok one.

 

[LDFerguson]

What is the significance of the internal charges?

With any deposit-based tracker, the bulk of the investment goes on deposit to provide the capital guarantee, a percentage goes to buy the option that provides the potential for better growth and a percentage goes in charges. If the charges are high then there's less money left to buy the option, which in turn means that the manufacturer has to buy cheaper options, e.g. options on obscure indices that nobody has ever heard of or ones with small-print traps like caps on each index etc.

 

[Brendan Burgess]

OK. But the potential returns quoted are the actual returns. There is no initial charge or ongoing charge?

As they are using fee-only brokers, does that mean that they are not paying any commission.

If I go directly, do I get a better deal?

Brendan

 

[LDFerguson]

OK. But the potential returns quoted are the actual returns. There is no initial charge or ongoing charge?

No. The potential returns quoted have taken account of the charges.

As they are using fee-only brokers, does that mean that they are not paying any commission.

If someone seeks advice from a fee-based broker and subsequently invests in this DI product, DI will refund some of the advice fee directly to the client.

If I go directly, do I get a better deal?

No.

 

[Duke of Marmalade]

[broken link removed]is the brochure.

My overriding observation is that IMHO the disclosure in this document is seriously in breach of the Consumer Protection Code. Let me explain. The CPC requires every Tracker to disclose:

a) The value of the guarantee (in effect the amount that is really on deposit)
b) The value of the "bonus", i.e. the cost of the Option
c) The charges, being the balance.

DI state that 100% is placed on deposit This is a totally inappropriate interpretation of the CPC, which ducks the key disclosure which is (c) above. Without knowing (b) and (c) it is impossible to properly assess this product.

But we can be greatly suspicious that this is deliberate obfuscation for it goes on to say that DI's fees are capped at 2.5%. But what about KBC's fees? What heightens my suspicion is that reference is made to the fact that KBC secures the return by using swaps i.e. rather than by buying Options. I am sure that is so, but this is no justification for misinterpreting the CPC which asks for disclosure of the open market value of the three constituents and is not interested with the actual legal form of the engineering. I urge Brendan to make a formal complaint to the CBI regarding this gratuitous non compliance with the CPC.

After that I approach everthing else in the brochure with mistrust.

I think it is entirely disingenuous to justify the choice of indexes on investment grounds. The section on diversification is also inappropriate. Diversification is bad for a Tracker. That is because it takes the volatility out of the basket but volatility is a good thing in this context. Volatility increases the value of an Option. This is indeed a highly diversified basket but it has been precisely so chosen because the option is cheaper, i.e. it is less valuable to the punter. Of course, we would not be left in this guessing game if there had been compliance with the CPC and we had been told the actual value of the Option.

There is 6 month averaging, though I don't see anything wrong with that.

Much better value tends to be available on these type of products from the likes of AIB and BoI. That is because these are outside the 5 year ELG period and punters get value for the high costs of funding for these banks. Of course, one might think these high costs are justified because of the risk of default.

 

[Marc]

So let's have a think about this product.

These products are designed to exploit investor's behavioural biases namely loss aversion.

The main issues are liquidity - there is no meaningful secondary market and therefore investors are locked in for 5 years without exit provision.

Interest rate risk - most of the cash is going into a fixed rate deposit with KBC for 5 years what if inflation and interest rates increase over the next 5 years? Will the rate still look as good?

Counterparty risks remains a problem post Lehmans. Who is writing the option? Capital protection is provided by KBC Ireland which is rated BBB- by S&P. I'd need to see the prospectus for the product and the articles of association for KBC Ireland before I could be satisfied that the parent bank's rating of A- was relevant.

Structured products do not generally participate in dividends or corporate actions.

There are other ways to replicate the payoffs provided by structured products and investors should not equate complexity with higher expected returns or other enhanced features.

Product sellers will only issue a structured product if they can generate the same payoffs at a price lower than the price they receive from investors.

So what about the payoffs?
Potentially getting your money back with no interest after 5 years subject to KBC not going bust.
Or 150% of three indexes capped at a maximum of 35%.

So what of the choice of indexes?
Euro stoxx 50? Fifty stocks? Why not stoxx 600 or MSCI World? Where is the Emerging Market exposure? There are 5000 stocks listed on the New York Stock exchange alone- what's wrong with Apple inc? Why so few stocks? Does this really suit anyone at all?

Ftse REIT index great love it fantastic way to get exposure to real estate but hang on why just the Europe index why not the developed world?

Commodities - Futures contracts are in zero net supply which means for everyone who is long wheat or oil there HAS to be someone who is short wheat or oil. If I add up all the futures contracts in the world I am left with nothing. I've already posted widely about why I believe that a commodities futures index adds very little to a portfolio that you can't get by owning BP, Exxon, Shell Etc.

So would I construct a portfolio around these indexes? In short no.

If you wanted to replicate this you could use 3 ETFS and a fixed term deposit.

However, you could build a better structure altogether.

How about

You could put 80% of your cash into a portfolio of fixed interest funds using low cost index funds.
european investment grade fixed interest 30%
intermediate term inflation linked bonds 30%
Global Short term fixed interest with a euro currency hedge 40%

That would give you an average credit rating of AA+ (rather than BBB-)
You would have full liquidity with access to all the capital retained over the investment term
You would have less interest rate and inflation risk
You would have less counterparty risk
However, you could not be certain that you would have a full return of capital on the 5th anniversary but is this really the most important factor since KBC do not guarantee to return you capital either. It is simply capital protected.

The remaining 20% you could invest in a global equity index including some emerging market exposure and perhaps some global reits.

You would then have a much more diversified portfolio of more securities and you would earn the dividends even if the final value of the indexes were lower at the end of the term.

Even using ETfs you could build this portfolio for around 0.5%pa. you would need to pay a stock broker to set it up but my broker in London only charges €30 trade and importantly you would not need to sell on the 5th anniversary. You could actually invest and just leave the portfolio.

I'm not suggesting that anyone should follow this approach exactly I am simply making the point that anyone with access to a low cost stockbroker could build a portfolio with a conservative lump designed to return their capital at the end of a period and a smaller lump designed to achieve real capital growth in excess of inflation to preserve their wealth.

It's called an investment portfolio and negates the need for anyone to ever invest in a structured product. Some people may choose to invest in a structured product but nobody needs to.

 

[Brendan Burgess]

The Duke and Marc

That is some great analysis which backed up my gut suspicion about this product.

Just one question:

KBC do not guarantee to return you capital either. It is simply capital protected.

What's the difference?

 

[Marc]

Brendan I guarantee to buy you a pint of Guinness in 100 years time provided I'm not dead first.

When is a guarantee not worth anything? when the body making it can't be 100% certain that it will honour it.

KBC could fail as Lehmans did. Now what is your guarantee worth? That would be for the courts to decide and Lehmans is still ongoing.

It is therefore capital protected not capital guaranteed.

 

[penury]

Brendan I guarantee to buy you a pint of Guinness in 100 years time provided I'm not dead first.

ask any investment adviser (IA) or a Financial adviser (FA) if they can guarantee to you that the investments you make through them are 100% safe and sure and that the return as well as the capital can be guaranteed. Marc comment regarding the pint.

As in life there is no guarantees in the world of finance & investments - like the casino the house wins every time.

Most every FA or IA that I know is in it for the money - your money, after all, its their job, they have to be paid... there is no free ride

I often wonder why the high flying analysts, hedge fund managers, stock brokers, or the IA & FA continue to work for a living?

You'd think other than for fun, they'd stop playing with or losing other peoples money

At your own risk

Rant over, back to my armchair

 

[Marc]

How is this related to my post or brendan's question?

Must be the sun.....

 

[North Star]

Good afternoon all,

If I may offer a couple of clarifications;

1) The brochure is fully CPC compliant and uses KBC standard disclosure notices which they use for all of their structured products. This has been cleared with the Central Bank and I will ensure that clarification on this point is provided to Brendan, early next week as this is a very important item

2) The key disclosure is as Duke points out "point c", i.e the charges. The total charges are 2.5% or 0.5% per annum. There are no other charges for KBC or any other party. We would recommend that anybody looking to invest in capital protected structures absolutely identifies the total level of charges. All other things being equal, the higher the level of charges then less is available to purchase the investment element, which can then reduce prospective returns

3) The product has a swap and deposit element with KBC as the counterparty in both instances. The objective was to keep the credit/counterparty risk with one counterparty so investors are clear as to who they are dealing with.

4) The terminology "Capital Protected" is used to increase investors awareness of any potential credit/counterparty risk. This term is being used more widely in the marketplace and we suppport that development as "Capital Guaranteed" can lead some of the more vulnerable investors to ignore the credit or counterparty risk. We provide a full page where we outline in some detail the Counterparty risk on page 17 of the brochure. The reality of the investment is that the Capital Guarantee or Protection as we prefer, is dependant on the Capital Guarantee/Protection provider. This is the same for any Capital Guaranteed/Protected products. In earlier product brochure drafts we had used "Capital Guaranteed" but had decide to change to "Capital Protected" which is a more acuurate and in our view appropriate description, especially for mor vulnerable consumers who might mis interpret the term "Guaranteed"

5) Duke, when designing the product first we selected the 3 asset classes that we thought to be "Value" first. This was before any option or swap pricing. Had any one of the indices been very low volatility or "cheap" then I would agree with you that diversification would reduce the value of the option. There is no attempt to use diversification to cheapen the option. We believe that if you are selecting a product which is Capital protected then it makes no sense to use very secure or low volatility underlying assets. You will see that there has been significant volatility in each of the 3 underlying assets. We may disagree on the "value" on each of the assets but that is a different debate and in our view the diversification adds value to the product

6) In addition Duke, we do not cap the returns of any of the indices. This is more expensive rather than cheaper. Our rationale was and is, that if any one index outperformed, we wanted all of that performance to count towards the client's end return. It would have been much cheaper to cap the returns on each of the indices, and to be honest we suspect that most potential investors would not be aware of how negative this could be in determining their total returns. I may be wrong but I am not aware of any other multi-asset type structure which does not have some cap on each of the indices. The no cap on individual indices is client "friendly" and our position is that this improves the investors prospects of earning a reasonable return

7) The total returns are capped at 52.5%. This is because we have a 150% participation rate on index returns up to 35%. e.g if the index performance is 35% then the client return is 35 X 150% = 52.5%. We selected a high participation rate to improve prospective returns for a lower level of overall index performance

8) There is averaging in the last 6 months of the product. This is the only "structuring" element of the product and was only included because there is a strong bona fide case for protecting any gains made for the last 6 months. In all other elements of the product we selected what we thought were the investor "friendly" options. There are legions of strategies/tricks used in the broader marketplace to cheapen up the option element, which in our view reduces the prospects of the client earning a reasonable return. None of these were used in our product with the exception of averaging in the last 6 months. We have outlined our reasons for selecting this feature above

9) The product is covered by the Deposit Guarantee scheme of €100k per person per institution. We want independent advisers to advise clients as to the suitability of this product and this includes the protection provided, or not as the case may be, by the Deposit Guarantee Scheme

10) The total charges are 2.5% or 0.5% per annum. This is in our view very competitive. For amounts invested over €75k we will refund 50% of our fee directly to the client. In this situation our fees then fall to 0.25% per annum. Please compare with what is available elsewhere, and I am happy to stand corrected if our product doesnt meet any reasonable definition of "low cost"

11) The product, and these types of products may not suit everyones objectives/preferences and we fully accept that point. They have their advantages and limitations. However as Liam has said there are large amounts invested in these products each year. Our position would be that if you are going to use any of these type of products then at least select a straightforward and low cost one.

12) We would also recommend that any potential investor considering any capital protected products, including ours, take independent fee based advice to make sure the product suits them and also to point out any hidden catches which may not be obvious to the man in the street. These will have a negative impact on your returns. This avoids an advice process which is purely commission based, which has been covered many times on AAM

13) We appreciate feedback both positive and negative as we can reflect that feedback in any future products. As mentioned above our objective is to provide straightforward and low cost investment solutions that could reasonably be considerd "investor friendly". Debate is nearly always a good thing, and anything that helps consumers come to a position where they can make an informed decision is to be welcomed. If there are other queries I will endeavour to answer them as clearly and as promptly as possible.

Kind regards Vincent Digby
Direct Investments and Impartial.ie

 

[North Star]

P.S I forgot to mention the following:

In general I would agree with Brendans suggested value equation/proposition when assessing these type of products.

In returning for surrendering a known return in Brendans example 19% you earn the right to have the potential of returns from zero up to 52.5%. The probability of those in excess of 19% returns and the individuals utility value for the returns above 19% will be up to each individual to assess.

Kind regards Vincent

 

[Duke of Marmalade]

Vincent,

Firstly, I appreciate your responding to my criticisms in this public forum. I am not accusing you directly of being non compliant, but let me convince you that whether deliberately or otherwise on the part of KBC, this brochure is quite seriously non compliant with the CPC. I quote below the relevant section:

Your proposed investment of €xx,xxx will be used, at the date of investment, as follows :
€xx,xxx , or xx%, will be used to secure the promised payment of €xx,xxx payable after yy years and mm months. This is equivalent to a promised return on this part of your investment of xx% pa, before tax is deducted.
€xx,xxx , or xx%, will be used to secure the cash bonus which may be payable after yy years and mm months.
€xx,xxx, or xx%, will be taken in [FONT=Calibri,Calibri][FONT=Calibri,Calibri]charges[/FONT][/FONT][FONT=Calibri,Calibri][FONT=Calibri,Calibri]. [/FONT][/FONT]If applicable, intermediary remuneration must be disclosed in this section.
[FONT=Calibri,Calibri][FONT=Calibri,Calibri]€xx,xxx Total [/FONT][/FONT]

Note that the three constituent elements add up to the Total investment i.e. 100%. Now it is stated in the brochure that 100% is placed on deposit and that 2.5% is the max taken in charges. To me that is a Total of 102.5%. If that were the end of it I would agree that my criticism could be regarded as nit-picking, but I believe that the non compliance runs much deeper than that. My read of the brochure is that Direct Investments comits to fees not exceeding 2.5%. I am sorry but I have been in this game too long to read that as meaning DI PLUS KBC comit to their combined fees not exceeding 2.5%. The Swap references convince me that there is smoke and mirrors going on here, perhaps KBC are misleading you. This would be oh so much clearer if the above disclosure as required by the CPC had been given.

I am sure that this non compliance is not a DI creation and that it is standard KBC procedure. I will be making a formal complaint to the CBI not only about the blatant non compliance of KBC in this space in general (and not just for this product) but that it appears to have their clearance.

 

[North Star]

Good morning Duke,

I am happy to provide clarification as required.

The disclosure wording used by KBC is used by other providers including Ulster Bank, please see here

There is a clear rationale as to why this wording is both used and is CPC compliant.

When structuring these type of products in general there are two approaches.
1) a zero coupon bond and a swap for the investment component or
2) A deposit account and a swap for the investment component

In the case of the zero coupon bond approach, the structure is as follows; 80% is placed in a zero coupon bond which will be worth 100% at maturity and if there is a 5% level of fees then 15% is available to purchase the investment option.

In the deposit account approach however the structure is different. 100% of all the funds that are invested are placed in a deposit account. From the interest that would be payable at maturity the bank provides both the fees payable and the investment option.
For the investor the net effect is exactly the same.
When using the Zero Coupon bond approach the disclosure notice format you provided works well. However when using the 100% deposit account approach, the CPC format you suggest does not fit as well. This is because all of the money i.e 100% is fully invested for the client.
Page 77 of the CPC, and just above the section you have quoted, highlights the 3 main required points under the "Where Does My Investment go?" All are covered and clearly laid out in the brochure.

I repeat that 2.5% are the total charges for Direct Investments or any other party. Swaps are used by most product providers as a way of booking the option risk and there are no smoke and mirrors and no intention to mislead.

We can pick this up again on Monday.
In the interest of fairness Duke, if either we provide enough evidence and clarification to convince you that the brochure is CPC compliant or if Central Bank confirms brochure compliance to you in person will you be prepared to withdraw your comments re non compliance with CPC?

Kind regards Vincent Digby

 

[Duke of Marmalade]

I attach below the formal complaint which I have submitted to the Central Bank.

I wish to make a formal complaint about what I perceive to be non-compliance with the Consumer Protection Code by KBC Bank.
The matter came to my attention through the popular consumer website AskAboutMoney. http://www.askaboutmoney.com/showthread.php?t=169452 will direct you to the relevant discussion. http://www.wp.directinvestments.ie/wp-content/uploads/2012/05/KBC-0226-1-Direct-Investments-Multi-Assets-Brochure_LR.pdf will link you to the brochure for the Multi Assets Tracker Bond.

It is a requirement of the CPC that the breakdown of a Tracker Bond investment is shown between the deposit element, the bonus element and the balance being the charges. In the first place this disclosure is not produced in the form specified by the CPC. More seriously it is represented that 100% is placed on deposit, and therefore by implication that there are no charges levied by KBC.

Reference is made to the fees of the product designer, Design Investments, and that these will not exceed 2.5%. In fact much is made of this low level of charges in the brochure. You will note from the discussion that Direct Investments assert that in fact KBC Bank do not levy any charges for their own account. I find this difficult to believe. If indeeed KBC are themselves enjoying material charges on this product my complaint takes on more significance than mere lack of formal compliance but points to a deliberate under disclosure of the aggregate charges on this product.

You will note that the approach to the CPC in this brochure is claimed to be standard KBC policy and that it has been cleared by the Central Bank. If that be the case, I suggest that KBC have seriously and serially misled the Central Bank.

I will be posting this complaint anonymously in the discussion. I give my personal and bio details below for your own benefit.

 

[North Star]

Hi Duke, if possible will you find out when CBI are likely to provide a response and will you keep us informed?

Kind regards Vincent

 

[Duke of Marmalade]

I understand that CBI do not respond to complainants but if they find any merit in the complaint they address the provider directly. I will of course keep AAM advised of any feedback.

 

[Sunny]

I don't like trackers by nature but have to say I think this brochure stands up with regards to disclosure. You can debate the product but I don't have a problem with the claims it is making. It is actually much more open about something like counterparty risk than many products I have seen. I still don't like the terms capital protected or capital secure in retail products but that's probably a debate for another day.

 

[Duke of Marmalade]

Sunny, I take the opposite view. The product seems okay and is devoid of some of the sneakier tricks. But there is inadequate disclosure (jury out on whether CPC non compliant) for me to assess whether this is good value.

We are told KBC provide the equity based return using a swap. The whole proposition can be seen as two swaps. The investor is swapping a conventional interest rate for an equity based return, KBC in turn swaps a conventional interest rate for the same return. How truly informative it would be if they told us how much they had to swap in the wholesale market. Armed with that figure we can now directly compare the value for money on the Tracker Bond with a conventional deposit. Without this information or the CPC equivalent we do not really have a clue (even me who has been at this for some time) as to whether the equity based return is good value.

As to whether it is a good investment proposition I am of the cynical view that no-one has a clue. I do believe that a fairly valued Tracker Bond is very attractive to many investors, who are afraid at both ends - afraid to lose any capital (but not too worried about interest) and afraid to miss out on a big market bounce. My personal preference is not to have any cap at all, but the cap on this product at 52% is quite high so it does represent a genuine punt of the foregone fixed interest.

In a sense the charges are a bit irrelevant, just as they are for conventional deposits, except that they impact on what is relevant - the value of the equity swap.

Given that KBC is covered by the Deposit Guarantee Scheme, I suppose the counterparty risk is neutralised up to the 100K.