What would be the ideal tracker bond?

[Marianne]

I've been thinking a lot about tracker bonds recently and can see some of their appeal - the possibility of a better return than deposit interest, with limited risk to your capital.

I've looked at a few and have read this thread with interest. While I can see the arguments in favour of creating a DIY tracker, I can also see that many investors won't have the knowledge or inclination to go off buying their own options.

Many of the tracker bonds and/or their marketing material I've examined are of poor quality, for various reasons: -

• Split maturity dates, with part of your capital earning a high rate of interest after a year. This to me makes it very difficult to evaluate the true rate of return of the product.
• Fluctuating participation rates, often pegged to some volatility index. Makes it very hard to evaluate possible returns.
• Other over-complicated methods of calculation. As well as making it hard to figure out your possible return, these can also mask risks.

So I'm wondering what the board would consider to be an ideal tracker bond.

I'll start off: -

• Simple structure - perhaps 100% participation and 100% capital guarantee.
• Counterparty risk clearly explained.
• Possibly a mix of indices tracked, e.g. a mix of an equity index, a REIT index, a bond index and a commodity index or some such?

I'd be interested to hear opinions.

 

[Brendan Burgess]

The ideal tracker bond, is to avoid them completely.

The next best thing is to construct your own.

However, if you want to force two separate products together and give shed loads of commission and charges to intermediaries, product developers, etc...

Explain in the literature the downsides e.g. non participation in dividends.

Track an index which includes dividends so a fair comparison can be made.

Keep it simple. Track only one index. There is nothing to stop you from having separate products. e.g. a FTSE tracker bond and an ISEQ tracker bond.
Al
Buyers apparently like varying maturity dates. Although, this could be achieved with separate products maturing on different dates.

Brendan

 

[Marianne]

Hi Brendan,

I'm aware of a wholesale developer of these products who charges, for example, 1.35% on a 3 year 11 months product. Intermediary commission is in addition to this. So if an intermediary took another 1.35%, that's commission of 2.7%. To me, this seems like a reasonable margin for not having to DIY. Remember these are mass-market products and the average bakery owner knows or cares as much about buying an option as I do about baking pies.

With a DIY product, presumably you have to work out and return your own tax liability on the option. With a packaged product, the return from the option is put into the deposit and DIRT tax is paid for you before you get your money back at maturity. That alone to me would be worth 2.7%.

I'd agree with your point about highlighting non-participation in dividends. If you're offering 100% participation and a capital guarantee, effectively the dividend growth and access to your capital is what you're giving up in return for the capital guarantee. If you don't like that price for a capital guarantee, buy into the index with dividend re-investment and take your chances with the ups and downs.

Having a series of products tracking different indices would be nice but not practical, unless you were sure of demand for each one, in order to book the relevant options at the suitable price.