Although they’re designed to be simple from an investor’s perspective, much goes on behind the scenes in capital- and income-protected products. Simon Hoyle reports.
Capital-protected and income-protected products are a little like the proverbial duck. On the surface – from the investor’s perspective – they seem serene, paddling around unperturbed, oblivious to any turmoil in markets around them.
But below the surface, there’s an awful lot more going on to keep things on an even keel, with hedging strategies and constant monitoring of assets to make sure that the product provider’s obligation to investors can be honoured.
The sophistication of techniques designed to provide guarantees – both of capital and of income – have evolved steadily over the years. From nothing more exotic than a bond-and-call structure, with capital guaranteed only at maturity, capital- and income-protected products now offer continuous protection, and offer investors a chance to withdraw capital at virtually any time they wish.
The development of capital- and income protected products mirrors the development of the securities and instruments available to fund managers to create, manage and honour guarantees – all at an increasingly reasonable cost to the investor.
Irene Deutsch, head of distribution for Macquarie’s specialist investments division, says the older-generation capital-protected products involved investors’ funds being invested in bonds and call options – bonds, so investors’ capital would grow over time and replenish the cost of the options; and the options, to capture any market growth. But capital could only be guaranteed at a specified maturity date.
Then came the so-called “threshold style” of capital protection, “where clients are invested in an underlying asset and cash at any point in time, and there are triggers that are a signal for [the manager] to move into cash…to ensure that the product was capital-protected at maturity”.
Deutsch says a common feature of these older products were break costs – often significant ones – if investors wanted to withdraw money before a maturity date.
“New generation products offer continuous protection,” Deutsch says.
“That means you can walk away during the life of the product, without incurring break costs.”
Deutsch says a case in point is Macquarie’s Flexi 100 Trust – a product that offers a geared, capital-protected investment in a number of different asset classes, with no manager-imposed penalty for walking away – although, if investors have geared and pre-paid interest, they may forgo the interest paid.
“It’s a very simple, flexible product,” Deutsch says.
The general manager of investment and retirement products for ING, David Kan, says there is growing interest among advisers for capital- and income-protected products.
“When we did market research and we spoke to advisers and investors – both before we launched MoneyForLife, in developing MoneyForLife, and we’ve just completed another round last month following up on the experience with it – certainly there’s a lot of people burnt by the financial crisis,” Kan says.
“They have seen large hits to their capital, going into retirement. This is particularly true of pre-retirees, and a lot of them had to modify their plans, basically work longer or reduce their lifestyle expectations.
“What either a capital-protected or income-protected product allows you [to do], in the lead-in to retirement, [is] to lock in the value of where you’re coming in. And ideally, you do not wait until the point of retirement; you actually need to lock in several years before that, so if you have an event like the GFC that happens on the eve of your retirement, or just before that, you’re neutralised against that.
“At the end of the day, capital protection is useful to a point, but you have to turn that into an income. The end goal is income, to support a lifestyle in retirement, and for an increasing time that you’re in retirement; so the real risk is longevity risk, which is outliving your retirement savings.
“You can take a product like MoneyForLife in the accumulation phase, and lock in an income base. For example, if you’re 55, let’s say, and you invest in MoneyForLife and you’re still working and accumulating, you can lock in that protected base – basically, put in a floor, but still let it grow, if markets grow, and lock that in, so by the time you retire you’ve got that protected base.
“We’re always looking at that, how to do it better and cheaper. And there are developments that happen along the way. For example, one of the capital-protected products we launched more recently last year, was a protected Aus50 fund, based on the Top 50 Australian stocks. Typically, with a capital-protected product, they use a price mechanism to allocate between a growth asset – in this case it’s the top 50 stocks – and then a ‘riskless’ asset – so let’s say cash.
“We introduced a modification to that, which is basically volatility-triggered, as well as price-triggered. So when markets become more volatile, which is typically when they’re going down, then the allocation to growth assets [is] reduced. And as they become less volatile, the allocation increases. So we’re always innovating on that, and we’re always looking, obviously, at ways to reduce price and to improve the features.