Kick Out Bonds

I know how much the adviser is making and I'm ok with that. This is one option broker has given me in response to me asking for European exposure along with Euro index tracker
 
caljaclew said:
I know how much the adviser is making and I'm ok with that. This is one option broker has given me in response to me asking for European exposure along with Euro index tracker
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Did he offer you an option where 50% of your money is invested in a cheap Eurozone Index tracker and the other 50% is kept in cash?
 
Whilst we dont like or recommend structured products like these, at least the OP's adviser was clear and transparent on what they were getting as remuneration, they seem to have explained the product features reasonably well and most importantly the OP has taken lots of time and effort to try to understand the pros and cons of the product. There is a lot of good behaviour being demonstrated here. Even if I dont like the product I fully respect the OPs right to make what they believe to be an informed decision.
 
But it's not really an informed decision.

There is no way that most people can estimate the likelihood of these various combinations of outcomes happening.

Those who can would not invest in the bonds.

I have read various brochures with these types of bonds. It often took me a long time to see the catch. In some cases, I didn't see it but knew it was there.

If someone invests in these bonds, they don't know what they are doing.

If a broker recommends them, it's because of the high commission they are getting.

As Gordon said - if you want this sort of investment - put 50% in cash, and 50% in equities.

Brendan
 

It's not a cop out at all.

You invest in cash, you have low risk and low return. If you invest in equities you take higher investment risk and therefore have a higher expected return. Within bonds nd equities, the different bonds/ shares have different expected returns. If you are looking for the next uber, you take the risk of getting nothing back in return for making 10 times + your original investment.

And I am not a professional investment advisor, I am a financial planner. I don't get involved with the valuation of stocks. I usually advise people to take the passive route or invest with Dimensional Fund Advisors.



Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)
 
caljaclew said:
Cant see a way to attach a PDF. Steven I note you did in one of the posts. Can you advise on the method
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When posting a reply, there's 3 buttons on the bottom right hand side, the middle one is upload a file. Click that and attach the file.
I was hoping the graph would be displayed but I reckon it's too big a file
 
Gordon Gekko said:
My fear is that these products are being missold and that at some point an OAP or other vulnerable client will have their capital base permanently devastated when one of them blows up.
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Gordon

Do you not think that's not already happening? Retiree with tax free lump sum after retirement or life's savings. Sick of getting no return from deposits? Stick it in this bond, all the upside of equities, with none of the risk. Nice shiney brochure telling of how your money is protected and you can earn 10% (TEN) a year!

Except if things don't go to plan and you try to get your money out after 3 years, you are told you can't get it until year 6. Or if things get really bad, you find out that the downside protection you thought you had is now gone and you're on your own.

Don't underestimate the amount of unscrupulous "advisors" there are out there. People who don't know the basics of pensions rules but can calculate commission payments in the blink of an eye.


Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)
 
Gordon Gekko said:
Did he offer you an option where 50% of your money is invested in a cheap Eurozone Index tracker and the other 50% is kept in cash?
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Hi Brendan, I think its quiet straight forward here what the likely combinations of outcomes are and that's why I'm considering investing. There seems to be an overriding bad feeling for these products which is far from my experience to date. Your saying you didn't see a catch but knew it was there. That sounds like a large bias impacting your opinion. Apologies if that sounds harsh.

I was hoping to have someone look at the 'product' as I think I understand it to its full extent but the general response is a generic these products are no good, they only benefit the seller, the counter party is not JP Morgan anymore and use a 50% deposit/50% tracker option instead which is what was suggested in the Roy Gillen article above but pretty much debunked in the BCP reply that I cant seem to post. Sean Barret had mentioned an option to upload when replying in the bottom right corner that I don't seem to have or see.

So assuming I'm happy and aware of the fees and counter party etc how does the investment look. I'm looking for the catch that Brendan mentions and hope someone can please point it out to me.
 
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Hi Caljaclew,

If I act for the prosecution re potential 'catches' for a moment, here are my thoughts;
  • Credit Risk 1 - this is binary, and if your protection provider fails then what are you going to get back post liquidation and when will you get that?
  • Credit Risk 2 - its nearly impossible for ordinary investors to gauge or price properly for credit risk. What use are current credit ratings or Credit default swap spreads as a guide? when we know that credit ratings are nearly always behind the curve, and CDS spreads move rapidly wider as stress emerges. If an institution is experiencing stress then it can become more attractive for structured product producers to use these names as there is more margin left to buy the option element. If a protection provider starts to become stressed how will you notice and what options do you have to get your money back
  • Credit Risk 3 - New EU bank resolution rules are intended to protect tax payers - more banks will be allowed to fail ( even if this has already been fudged in Italy) , Is your product deposit based or off an MTN programme i.e. a security. If not a deposit then who exactly is the issuer? ( banks are restructuring via a holding company structure to separate secured deposits from other securities which may be expose to bail in risks)
  • Credit Risk 4 - if your capital is at risk ( which nearly all products are nowadays) then these products are NOT protected under the Deposit Guarantee scheme
Market Risk 1 - Risk of Permanent Loss of capital. If you loss 50% then unlike a fund or an equity you dont have the option of holding the investment till it recovers. At maturity or earlier with a structured product you have the loss inflicted upon you. I accept that you can of course re-invest the smaller proceeds to not lose the recovery but a) emotionally this can be difficult after a big loss and b) you are now at a material tax dis-advantage if the product is liable to exit tax i.e you are now liable for tax on any gains on the re-investment which would not have occurred if you were holding an original investment till it returned to par
Market Risk 2 - Probabilities - It is nearly impossible for ordinary investors - or advisors! to gauge the probabilities of the various outcomes.

I think that there are enough 'catches' here to lead us to our view held over the last several years not to recommend them to clients.

In your favour, you have taken the time and effort to identify a list of potential outcomes and have determined that you are comfortable with these outcomes. You deserve credit for doing so. I have concerns that some are sold these products under the illusion that they are "guaranteed" when they are not. I still believe it is near impossible for us to work out what the probabilities are attached to your range of outcomes and what is the appropriate price for the credit risk?
 
Thanks so much Northstar for taking the time to post that. It's much appreciated. Can I ask in relation to credit risk does the same risk apply for example on the index tracker fund that I was also offered or on your average life company funds or is it different for them.
 
Hi caljaclew,
Yes for all structured products where as part of the structure you place funds on deposit or you buy a security issued by the bank you are exposed to the bank failing i.e credit or counterparty risk. In both cases you have deposited funds/lent them money. If the bank fails then your funds are at risk. The other main risks in the product are the investment risks, where you have identified a range of outcomes. Whilst it may be a low probability event that a bank fails, if it happened the impact would be very material and the risk should be taken into account. With the life company fund, your main risk is the investment risk.
 
Thanks again North Star and one final question if you don't mind. Where would the credit risk be with a typical fund, eg the popular GARs or BNY Mellon Global Real Return. Is it right to assume there is zero credit risk with managed funds and if so why is that the case ? Apologies if that's a stupid question.
 
With the managed funds, be they equity or the absolute return funds you mention, your risk is the market risk i.e do they go up or down in value. If a life company became insolvent, it is very unlikely ( though you cant say absolutely impossible in an extreme scenario) that you would lose any material amount. In Standard Life's case with GARS there is an explicit UK Govt guarantee to protect the full value of your investment at the point of insolvency, if Standard Life went insolvent. This guarantee is unlimited in size so for now you can safely say ( if you have confidence in the AAA rated UK) that there is no credit risk. Brexit may complicate this in the future.
The reason why a unit linked life company that is not involved in guaranteed annuity returns is much more secure than a bank is reasonably complicated. Its probably easier to explain on a call. Pm me if you want to have a call to discuss that aspect of your query.
 
Hi calja unfortunately I am in South of France at moment without access to my forensic tools for analysing these things.

However it is an excellently produced brochure and for once I am prepared to believe their 'backtest' is a reasonable guide to its potential, although I presume the stocks were chosen to backtest well (especially with regard to the number of disaster outcomes).

The backtest produces the following results:
45% of times it kicks out after 1 year and you get a return of 10%
39% of times it kicks out between year 1 and maturity and you get 10% p.a. (this is essentially what you are hoping for)
so far so good, you are easily beating deposits 84% of times, though note that this is tilted towards 1 year so not a huge winner
On the 16% of times it reaches maturity without kicking out, in 13.5% of these you just get your money back and the other 2.5% disaster - you lose more than 50% of your capital

This is not too good to be true, it about stacks up and the 5% total fees (built in) is reasonable. (They would be very reasonable for a genuine 5 year product but this in effect is only about 2.5 years because of the kick out mechanism)

So I think it is a fair product but it is not for me. It is a bit like playing a roulette game where the odds are stacked in your favour* but you have to take a chance of losing your shirt on one number whilst doing modestly well in the great majority of outcomes and simply getting your money back on a sizeable minority of outcomes.

There could also be some very sweaty moments where coming to maturity you could be hovering between a very big loss and simply getting your money back.

On tax this one is called a preference share which at least sounds better than a note. Nonetheless I would check with Revenue that it is genuinely CGT.

Finally forget about the credit risk. The one thing the financial crisis has taught us (ironically) is that there is almost no credit risk with a blue chip institution.

* the theory goes that if you take investment risk, the odds will be stacked in your favour, the nerds call this the equity risk premium. In retail products these favourable odds have to be shared (or gobbled up entirely) by the provider/distributor. Some rough sums suggest that this product does leave some of the risk premium on the table for the punter, but as I say the shape of the risk reward profile would not be for me.
 
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Thanks for your input Duke. It's interesting to see another viewpoint on the credit risk issue. I'm assuming your an adviser and in your mind it does not exist yet its upper most in the thoughts and views of others on this.
 
caljaclew said:
Thanks for your input Duke. It's interesting to see another viewpoint on the credit risk issue. I'm assuming your an adviser and in your mind it does not exist yet its upper most in the thoughts and views of others on this.
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Good lord no, I'm not an adviser With the bulk of my 'umble pile in Prize Bonds, State Savings and cash, I'm the last person to advise anyone.

I was making the point about credit risk for effect. I think the risk is overegged these days, and the fact is no punter has lost out even if their bank turned out a basket case, like most depositors here in Ireland.

Oh, I know there is a big pretence that next time will be different, no bank will be too big to fail. Well, the reasons for TBTF haven't gone away, the idea of letting a major institution go to the wall is still an appalling vista which the authorities will avoid at all costs.
 
Hi Duke,

That's all well and good in terms of the past, but it is now stated policy that depositors etc will be bailed in the next time a bank goes bust.

Gordon
 
Gordon Gekko said:
Hi Duke,

That's all well and good in terms of the past, but it is now stated policy that depositors etc will be bailed in the next time a bank goes bust.

Gordon
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That was (unstated) policy last time but when push came to shove the banks were TBTF. Having said that I myself limit my exposure to any bank to what's covered by the deposit guarantee. I also agree that these structured products may be seen as fair game to pursue the normal insolvency route whilst conventional deposits might remain a protected species.

Returning to an assessment of the structured product in question, in absence of my forensic tools and using the backtest as a guide I did the following assessment:
50% chance k/o end year 1
15% k/o year 2
10% k/o year 3
5% k/o year 4
3% k/o year 5
12% money back at maturity
5% lose 70% at maturity

Using Google Sheets I get an IRR of almost exactly 5% p.a. gross.
This is fair and believable. It is additionally attractive to anyone who has CGT losses to shelter these gains.

But as I said before and as Rory Gillen observed in his critique you are being the 'bookie' here in the sense that you are taking a small risk on a large amount in the expectation of scooping up the bets. The difference is the bookie hopes to make a book by entering a lot of such transactions thus cancelling out any risk. Such an option is not available in our case.
 
Hi. there is a small related point here worth making - there is credit risk in buying a life company fund (it's just not disclosed). Life Company Funds are not like UCITs/OEICs/SICAVs. In the latter you have 'market risk' only. Whereas with Life Company Funds (Irish Life, Zurich, New Ireland etc.) you take on the balance sheet risk of the company. And this is why Life companies can pay financial brokers 3.5% commission today and typically 0.5% per annum (though the other main reason is that Life Companies restrict liquidity and enforce an investor penalty on withdrawals thereby cheaply locking in 5 year money for themselves which is typically more expensive than 1 day money which is effectively what managers of UCITs/OEICs/SICAVs must deal with i.e. a manage of a UCITs/OEICs/SICAVs deals with daily inflows and outflows). It always strikes me as odd that in Ireland we have this particular phenomenon whereby the Life Companies are the major player in the investment industry yet never seem to have to provide detailed information (read any of their brochures) with regard to the particular repackaging they do of UCITs/OEICs/SICAVs, the inherent and undisclosed credit risk and how they manage to control the market through the payment of extraordinary fees to financial brokers. Over the last number of years a number of UCITs/OEICs/SICAVs managers have tried to enter the market but have been blown away by the domination of the Life Companies and the commission structures. Slightly off topic here but worth pointing out I think.
 
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