Offshore investments with minimal volatility

Market volatility has been the order of the day for the past six to eight months. This is even more true for clients who had investment portfolios with heavy offshore exposure. This is nothing out of the ordinary, and investing in a global investment portfolio requires investors to tolerate extreme market volatility at times, as has been seen recently.

Tech stocks, which have been broadly the darlings of the global market for the past 10 years, are down nearly half their value from recent all-time highs. Soaring US inflation and supply chain backlogs have caused numerous economic woes, and as you could probably have predicted, the pain of the initial harsh lockdowns of 2020 is only now beginning to erupt through the net. Money printers in the US were also starting to cool off, meaning the “easy money” is being taken out of the economy and the money thrown at these tech darlings has dried up.

Investors currently sitting on cash (both local and offshore) are caught between a rock and a hard spot. Holding your money in cash is leaving it to the inflation wolves, and exposing your capital to the financial markets also seems like an extremely good way to lose your money. It’s almost as if investors have to make the following decision:

  1. Lose 7% per year in cash, or
  2. Losing 17% a year in the stock market.

Long-term wealth accumulation rules out option A above, as inflation is a guaranteed way of losing the purchasing power of your money. Holding capital in cash will get you nowhere. You take no risk and are rewarded accordingly. You must play the hand that is dealt to you.

Investors looking for superior returns need to shift their asset allocation up the risk curve to avoid a flat portfolio. After all, the biggest risk is not taking a risk.

The answer to this problem? A structured product offers a guarantee of capital while providing upside risk to the global equity market.

What is a structured product?

A structured product is a five-year equity-linked investment product that tracks the growth of diversified global equity markets. This structure is operated by a specific company (Investec/Momentum etc.) and varies in structure and composition. Various structured products are available in the market, some with greater equity exposure than others. Some products also have a different participation rate on the upside than their competitors. The initial investment period for these products is five years.

Investec provides capital preservation for investors’ capital through the issuance of bonds, but only if they are held to maturity. Profits from the product are locked in at each stage, meaning that when new shares of the company are issued, whatever investors have earned up to that point will remain if they choose to hold the shares for a second stage hold and not sell them.

For example, a structured product offered by Investec through the East Asian Growth Basket offers a 100% capital guarantee at maturity after five years with a 40% growth cap for the basket. Simply put, for the following three scenarios, your return on investment will be:

1: THE FIRST ROW: represents a downside scenario; The index returns -50% after five years, but the investor still got 100% back due to capital preservation.

2: THE SECOND ROW: represents a total return of 30%, giving the investor 130% of their seed capital

3: THE THIRD ROW: continues the scenario. The index delivered a 150% return over five years and the client received 140% of their seed capital.

What is the goal of a structured product?

The greatest competitive advantage when using a structured product is the guarantee of the initial capital, even if the investment value on the termination date is lower than the initial investment. Below is a representation of what happened to investors in Investec’s structured product during the 2009 market correction.

Volatility affects investment returns, particularly when clients react irrationally in volatile market conditions like the ones we are experiencing. If an investor had to purchase protection in a global stock index, it would cost the investor about 18% of the investor’s initial capital. Investors in structured products such as the East Asian Growth Basket do not incur these costs.

Who should consider this investment product?

Investors currently sitting on cash are busy reducing the purchasing power of their capital by around 6-8% per year and even further in current market and economic conditions. With the possible increase in the price of fuel around the corner (R3/litre), inflation will most likely be higher in the short to medium term.

Therefore, alternatives must be examined from an investor’s perspective. Current market volatility is expected to remain a factor, at least in the short to medium term, and investors with a long-term investment horizon who stick to their plan will reap the rewards. However, some investors are inherently more risk-averse and do not want to expose their capital to the full brunt of the financial markets. This is where these structured products offer investors extremely high added value by protecting their initial capital from the aforementioned volatility and offering them high exposure to the upside of the portfolio.

Below is an excellent reference to the historical performance (November 2004 – March 2022) of a similar structured product from Investec (the Optimal investment growth basket). The chart shows that on each expiration/roll of the stock, the investor managed to lock in profits and reduce risk as the new expiry value at maturity becomes the new 100% protected value of the new stock at maturity (if investors decide to have decided to roll the investment). Forward.)

Because the investor has a known worst-case expiration value, he/she can avoid medium-term volatility. When markets crash, investors can avoid losses by cashing out the minimum capital-protected value.

Investors are typically faced with two typical investment decisions; Investing in stocks – which historically have offered a better return than interest but with volatility along the way and capital at risk – or investing in, say, an interest-bearing investment or a fixed-term deposit account at the bank. The latter offers capital protection and known interest payments.

summary

Market volatility and market declines have been the best opportunity for investors to get a good exposure to the financial markets to date. The current pullbacks should be viewed as a good time to add to certain market positions, especially over the long term.

Nonetheless, structured products also present an excellent opportunity for the risk-averse investor who does not wish to invest all of their capital in the equity markets, particularly on a global scale. Other investors may have a short to medium investment objective and may simply not be able to fully invest their capital in the financial markets. The structured nature of these products, mentioned above, gives these investors the perfect opportunity to benefit from rising market opportunities while, in the worst case, having the peace of mind of having capital protected at maturity.

Investing in these products should be done in conjunction with a professional financial/investment adviser as different structured products are available from different money managers, each with their own technical differences.

About Christine Geisler

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