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.

 

[Duke of Marmalade]

Just 2 months to go till this 5 year product matures.
Reminder it was benchmarked against the EuroStoxx 50 which the proprietary index beat by 4.5% p.a. in the 18 years prior to launch.
The deal was that if the prop index was not less than its starting value at its 5 year maturity you would get the greater of +40% or how the prop index had actually performed.
Thinking EuroStoxx that would be a no-brainer to the financial advisors who recommended it to their clients.
But just to assuage any doubts, the brochure points out that in over THREE THOUSAND backtests every single one delivered at least the +40%.
As you can see form the below graphic, the Tories have more chance of winning Thursday's UK GE than these suckers have of getting what would have seemed and indeed presented to them as a slam dunk.

 

[nest egg]

Just 2 months to go till this 5 year product matures.
Reminder it was benchmarked against the EuroStoxx 50 which the proprietary index beat by 4.5% p.a. in the 18 years prior to launch.
The deal was that if the prop index was not less than its starting value at its 5 year maturity you would get the greater of +40% or how the prop index had actually performed.
Thinking EuroStoxx that would be a no-brainer to the financial advisors who recommended it to their clients.
But just to assuage any doubts, the brochure points out that in over THREE THOUSAND backtests every single one delivered at least the +40%.
As you can see form the below graphic, the Tories have more chance of winning Thursday's UK GE than these suckers have of getting what would have seemed and indeed presented to them as a slam dunk.
View attachment 9018

For the slow 'nest egg' learners in the group Duke...

I invest €100 in 2019. I'm told if the SAB >= my €100 in 2024, I get €140 (or even more if SAB delivers). I say to myself, this is safe bet, especially with all that past performance data to back it up. Incredibly(!), come 2025, the SAB is worth < €100 and nest egg gets whatever it's worth at that point.

So the game here is purely about fees I assume, do you have any insight as to what they were, and how the spoils were divided?

 

[Duke of Marmalade]

@nest egg yep, you've got the picture. No, it is not about fees. The Key Information Document (KID) required by EU law sets out the costs 1.44% p.a. over the 5 years of the product.

1.44% p.a. is not excessive by industry standards. The fact of the matter is that with zero/negative interest rates (in 2019), a product which guarantees a minimum return of 85% (max loss 15%) really hasn't got much potential,
The real question is how did a proprietary index (constructed with hindsight) beat its benchmark by 4.5% p.a. before it was launched but undershot its benchmark by over 50% in the 5 years of products actually based on the index.

 

[nest egg]

@nest egg yep, you've got the picture. No, it is not about fees. The Key Information Document (KID) required by EU law sets out the costs 1.44% p.a. over the 5 years of the product.

1.44% p.a. is not excessive by industry standards. The fact of the matter is that with zero/negative interest rates (in 2019), a product which guarantees a minimum return of 85% (max loss 15%) really hasn't got much potential, Again the KID makes this clear as the following projections show.
The real question is how did a proprietary index (constructed with hindsight) beat its benchmark by 4.5% p.a. before it was launched but undershot its benchmark by over 50% in the 5 years of products actually based on the index.

Seems there's a perverse incentive at play Duke. If I create a fund like this, and sign up a load of punters, but I also know I can avoid paying them a top-up if the fund is worth less after 5 years, 'Machiavellian-nest egg' might setup the fund to maximise their chances of 'success'.

What I'm trying to understand though, after all this trouble I've gone to, if not the fees, what's in it for me?

 

[Duke of Marmalade]

Seems there's a perverse incentive at play Duke. If I create a fund like this, and sign up a load of punters, but I also know I can avoid paying them a top-up if the fund is worth less after 5 years, 'Machiavellian-nest egg' might setup the fund to maximise their chances of 'success'.

They are careful about that. The "fund" is actually an algorithm - 4 filters. Having found an algorithm that beats the pants off EuroStoxx in the past they hand it over to Solactive who specialise in operating such algorithmic indexes - I thing they have over 8,000 of them, many quoted on the Luxembourg stock exchange.
But it has inbuilt mechanisms which make the index (much) less likely to deliver than its benchmark, e,g. concentrating on low volatility stocks and stocks about to shed a dividend (they include such stocks in the index on a rolling basis). They do not try to hide these negative factors but claim that they have discovered mispricing of them in the option markets. Key to this is the incredible past performance, completely defying the negative headwinds.

What I'm trying to understand though, after all this trouble I've gone to, if not the fees, what's in it for me?

Sorry, I though you were thinking in terms of the 50% shortfall on benchmark being consumed in fees. No, they do it for fees of course but nothing out of the ordinary that I can glean. Remember at the time it was a real struggle to come up with these structured products which are so reliant on swapping the interest rate for the option costs. Note that all this effort is not just for the Paddies - they presented the index to UK financial advisors and these structured products are all the rage in their homeland, France and other €-countries.