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Looking to Diversify?

Colin Mclachlan, Lowes Financial Management

Whether considered as a fundamental component of a portfolio or as a standalone element, we believe that a blend of structured products, providing balanced counterparty exposure, can offer significant added value.

Although there are a number of products currently available that could complement each other within a wider investment portfolio, many investors will struggle to diversify efficiently, not so much because they can’t meet investment minimums but more likely due to the administration burden of doing so, which doesn’t stop when the investment is made. There are a whole host of non-investment related matters to make life difficult, e.g. not on platform, liquidity windows for surrendering might be only monthly, poor visibility of the market-to-market price and then there is the maturity and potential reinvestment process to consider. The potential return offered has to more than compensate the effort of maintaining the exposure to gain the diversification mentioned so many words ago!

One solution is the Lowes UK Defined Strategy Fund which will be a portfolio of autocall strategies aiming to generate improved returns to plans offered in the retail sector. At least 80% of the assets within the Fund will be linked to FTSE 100 Index only strategies and these strategies will mostly be collateralised with UK Gilts, exposing the Fund to credit exposure of the UK Government, rather than individual banks. The Fund also has the flexibility to invest in structured notes, which would expose the Fund to bank default risk in return for improved potential returns. In addition to diversification of credit exposure, the Fund will diversify Index observation levels and dates to mitigate some of the market risk.

For those advisers who prefer standalone structures, three tempting options which might be considered for broadening a diversified portfolio are the Societe Generale UK Kick-out Plan (UK Three) Issue 2, Societe Generale UK Step Down Kick-Out Plan (UK Three) Issue 2 and Investec 8:8 Plan Issue 6.

Societe Generale launched their current maximum eight-year UK3 range on 19th October 2018 and due to heightened pricing conditions at that time, they’ve managed to issue some attractive contracts. The first being the Societe Generale UK Kick-out Plan (UK Three) Issue 2, which will pay a potential return of 11.8% per year held. The underlying measure is the FTSE 100 Index but no index growth is required in order for the plan to mature early. Providing the FTSE 100 Index closes at, or above its initial index level on any annual anniversary from year two onwards, it will mature returning an 11.8% gain for each year held.

The second option is the Societe Generale UK Step Down Kick-Out Plan (UK Three) Issue 2 which will pay a 9.15% return for each year held, providing the FTSE 100 Index closes at, or above a reducing reference level. The reference level in year two, three and four is 100% of the initial index level and this level is reduced by 5% on each subsequent anniversary and so will be 95%, 90%, 85% and 80% of initial level for years five, six, seven and eight respectively.

The third option is the Investec/Lowes 8:8 Plan Issue 6, which also contains a defensive investment feature to the extent that from the first observation and everyone thereafter, the index can be up to 8% lower and still trigger a maturity. The potential return is 8% for each year held (4% for each half year) and a maturity will be triggered on the first six monthly (rather than annual) observation, from the second anniversary onwards that the FTSE 100 Index closes no more than 8% below the initial index level. The maximum duration is eight-years.

All of these investments put capital at risk of loss from market movements however, the 'barrier' for these investments dictate that no loss should arise from market movements unless the FTSE 100 Index performance is such that a positive maturity is not triggered and at the end of the maximum eight-year term, it is 40% or more below the initial level, in which case the investment return will reflect the fall in the index over the full term.

Another important distinction between the three plans relates to counterparty risk. All such investments are effectively loans to banks and if the bank defaults and cannot meet their contractual obligations a significant or, in extreme circumstances, a total loss, could arise. The Investec/Lowes 8:8 Plan is wholly reliant upon the bank itself meeting its obligations, whereas the terms of the two Societe Générale plans have been enhanced by adding further credit default exposure to three other UK institutions (Barclays Plc, Lloyds Banking Group Plc and HSBC Holdings Plc). In the event of the failure of Societe Generale the plan’s assets are collateralised to the extent that whilst an enforced early maturity is likely to occur and this could result in a loss, it should never be a total loss. If, however, one of the three UK institutions should fail, up to 33.3% of the investment will be exposed and in extreme circumstances all of that portion could be lost. If all three institutions fail then a total loss is possible.

We believe that all three plans outlined above are completing in their own rights and perhaps more so, when combined together in a broader portfolio – which is exactly what we seek to do via the Lowes UK Defined Strategy Fund.

Capital-at-Risk

The value of investments can fall as well as rise. You may get back less than you invest.

Disclosure of Interests

Lowes has provided input into the concept, development, promotion and distribution of the 8:8 Plan and is investment manager for Lowes UK Defined Strategy Fund. Lowes has a commercial interest in these investments as a result of its involvement. Where Lowes is involved in advice on these investments to retail clients, it will not receive benefit of any fees for its involvement, other than those fees payable by the client to Lowes. Lowes has robust systems and controls in place to ensure that it manages any actual or potential conflicts of interests in its activities.