INVESTOR’S NOTEBOOK STEPHEN CRANSTON
Have you ever noticed how people who develop structured products wear suits made from a more expensive cloth and have an extra swag in their swagger? Who can blame them, as they have the highest margin of any investment product. There is a price, though: they usually have to go around Sandton in a tuk-tuk as they are too embarrassed to show off their flashy cars to their peers in the bank. And that’s even true at Investec, that bastion of red-blooded capitalism. It makes Goldman Sachs look like the Salvation Army.
Journalists had a rare opportunity recently to meet the head of Investec’s structured products, Brian McMillan, to talk about the S&P 500 Rand Autocall. But then, it is that awkward time of year when it is too late for skiing in St Moritz, but too early for sailing in St Tropez. Some of the distributors will no doubt be heading in the same direction as the fee is a rich 1.25% up front and 0.75% in year two and year three. To be fair, McMillan went out of his way to be transparent. I found it a much simpler product than the competing offerings from Discovery Invest. It is linked to the main US index, the S&P index, but it doesn’t make sense to see it as an equity investment. However strongly the S&P performs and no matter how much the rand declines, the maximum that can be earned from the product in any year is 14%. It is one of the increasingly popular autocall products.
If the S&P has been positive after three years, the product winds up and the client gets three coupons of 14%, giving 42% (the returns don’t compound). A year later, if the S&P 500 is positive, there is a 56% return and if it only turns positive after five years, a 70% coupon. The big difference from equity products is that reassuring word “guarantee”. If the S&P is negative (in dollars) the client will still get his money back, as long as the index does not decline by 40% or more.
In the event of a 40% decline or more, however, all bets are off and the client has to take the full loss. McMillan says that based on data since 1928, the product would have lost capital just 5% of the time, and that was primarily in the aftermath of the 1929 crash.
Since then only the global financial crisis would have led to such a loss. And the capital guarantee would have been necessary less than 10% of the time. In fact, the chances favour a payout in the third year, which would have taken place 76% of the time.
McMillan doesn’t compare the product with equity returns and nor should prospective buyers. Instead he looks at the rate for a threeyear deposit at Investec Bank (5.1% net of tax), the average preference share (9.6%) and the Investec Money Market Fund (4.7%). It is much easier to get money out of any these three products than it is to exit a structured product. But Investec has listed the structure on the JSE and will buy it back, though it may be at a hefty discount.
After such an exposure to the lifestyles of the rich and famous it was pleasant to be in the familiar company of Nazmeera Moola, the economist at Investec Asset Management. She has become a selftaught expert on pain, and concluded that half of our pain is global, with weak commodity prices and tightening financial conditions, but the other half is self-induced flagellation with electricity constraints, labour unrest and regulatory uncertainty. We had come to hear whether she expected there to be a sovereign downgrade from S&P. I am not sure if my friend gave an answer as there were several instances of “on the one hand” and “on the other hand”. But she’s a great entertainer.