A personal take on structured products
Borrowing to invest, certainly from a retail investor perspective, is rarely a good idea.
That said, it is far from uncommon for people to have a mortgage, being their long-term house purchase borrowings, whilst at the same time having investments, often seeing the two as completely unrelated.
I am very fortunate to have an offset mortgage at 0.48% over Bank of England base rate. Given that I originally borrowed far more than I needed to buy the house, offsetting the excess immediately, what this represents to me is a significant overdraft facility where I can borrow money currently at less than 1% per annum.
Borrowing at a very low rate of interest to invest starts to make more sense. For example borrowing to invest in an instant access deposit account paying 3% gross will give me a guaranteed, no risk, after tax profit. Borrowing to buy Premium Bonds should, with average luck, do the same but with no luck will cost me no more than £300 a year on the maximum number of bonds.
Occasionally I will choose to invest in capital at risk investments using this low cost ’overdraft facility’. When doing so I am accepting that if it all goes wrong I will be left with the debt to repay and so have to consider the risk carefully. (blog continues below)
Last year I drew on my offset facility to invest in the Walker Crips Annual Growth Plan Issue 9. This offered a potential gain of 7% for each year the plan was in force and would mature on the first anniversary that the FTSE was at or above the level recorded at commencement.
The risks were that if HSBC, being the counterparty to the investment, were to go bust I would potentially lose all of the capital or, if the FTSE 100 was not higher on any anniversary for the next six years I would at best be receiving just my capital back having paid interest on it for six years and at worst, if the index was more than 50% down at the end of the term I would lose an equivalent percentage.
These were risks I was prepared to accept particularly as any gain would be subject to the more favourable capital gains tax regime. Furthermore, at a borrowing cost to me of 0.98% pa the 3% adviser commission built into the terms of the plan would cover my cost for over three years.
At the commencement of the plan the FTSE struck at 5900.76. Being reasonably high it soon became apparent that the investment might run for a few years. As long as base rate did not rise significantly this would not necessarily be a bad thing, as the investment would accumulate 7% potential gain for each year held. As it was the plan matured on the first anniversary in March this year as the FTSE closed at 5902.7, just 1.94 points above the strike level.
At maturity I could have simply banked the capital, offsetting the mortgage, having achieved a net gain of over 9% but instead I rolled over part of the maturity into the Walker Crips Defensive Annual Growth Plan Issue One, again committing to a maximum six year investment term. This plan can only mature from the second anniversary onwards and will do so if the FTSE is no more than 10% below its initial level. The potential coupon is again 7% for each year held. As the plan struck at 5772.15, the reference level for an early maturity to occur is therefore 5194.94.
As with previous plan, the terms incorporate a 3% commission which, at current rates will cover my borrowing cost for 3 years, capital protection is provided up to a 50% end of term barrier and the counterparty is again HSBC Bank.
I am of course hoping that when the plan matures, be it on the 2nd, 3rd or whatever anniversary the FTSE 100 is significantly higher than the required 5194.94, let alone 5772 where it was when the investment commenced. If so it could make the 7% for each year held look low by comparison to the rest of my portfolio but I know that I do not know when and by how much the market will rise. The 7% maximum return for each year held is lower than that which could be achieved if I put the money directly into the market but that is a function of the risks being lower and different.
Whatever the future has in store, I will be delighted with this element of my portfolio, as long as HSBC stays in business and the FTSE 100 is above 5195 on at least one of the relevant anniversaries. I don’t expect there are many investment advisers who believe this won’t be the case and/or that the FTSE will be below the 2886 barrier on the sixth anniversary. But I know that by investing I have accepted the risks.
Ian Lowes is founder of StructuredProductReview.com.
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