Defensive growth plans with structured products can provide good outcomes even in a market downturn but differ in their approaches, writes Ian Lowes (pictured).
Defensive growth plans are becoming more prevalent in the structured products market. In late 2011, Morgan Stanley first released its FTSE Booster Plan series, which offers a positive return even if the market has fallen by up to 50% after six years. Barclays recently released the latest version of its five-year Target Growth Plan, offering a fixed return of 38.5% even if the market falls by up to 40% during the term.
Subject to a maximum potential return of 160%, the Morgan Stanley FTSE Booster Plan 4 is a six-year investment offering a total return at maturity equal to two times the final index performance, which is the final index level expressed as a percentage of the initial index level. So, if at the plan’s maturity the FTSE closes no worse than 20% below its initial level, investors will receive the maximum total return of 160% (at the end of six years). If the FTSE 100 Index is at, say, 75% of its initial index level at maturity, the total return will be 150% (two times 75%). This means that, provided the FTSE closes above 50% of its initial level, investors should receive a gain.
The Barclays Target Growth Plan April 2012 Edition is a five-year investment that offers a potential gain of 38.5% of the original investment at maturity, provided the FTSE 100 index closes at a level no more than 40% below the initial index level on every day of the investment term. Even if the FTSE 100 Index closes more than 40% below the initial level on at least one day of the investment term, provided it is above the initial level at maturity, investors still receive the full 38.5% gain.
Under the Morgan Stanley plan, if the index has fallen by more than 50% over the six-year term the investment will give rise to a loss. However, the loss will be less than 1% for every 1% the index has fallen. For example, if the index falls by 60% over the investment term, resulting in a final index performance of 40%, investors should receive 80% of their initial capital (two times 40%). If the index has fallen by 80%, the final index performance would be 20% and so investors would suffer a 60% loss.
The Barclays Target Growth Plan offers a different type of structure. If the 40% barrier is breached at close of business on at least one day during the investment term, then both the maximum potential return of 38.5% and the initial capital will be reduced by 1% for every 1% the final index level is below the initial index level.
For example, if the 40% barrier is breached on any day during the five-year term but the final index level is 10% below the initial index level, then both the maximum return and the initial capital are reduced by 10%, so that the return now becomes 24.65% at the end of the five-year term. If the FTSE finishes 50% below its initial level, then both the maximum potential return and the initial capital are halved, giving a loss of 30.75%.
Therefore, the FTSE would have to close on any day of the term more than 40% below the initial level and finish the term at a level more than 27.8% below the initial level to give rise to a loss from market movements.
Both banks act as counterparty to their own investment products. Barclays is rated as A+ by Standard & Poor’s, which indicates the ratings agency believes Barclays has a strong capacity to meet its financial commitments.
Morgan Stanley has a lower Standard & Poor’s rating of A-, and while this also indicates a strong capacity to meet its financial commitments it is to a lesser extent than Barclays.
Risk and return
Using a defensive strategy involves a trade off between risk and reward. The Morgan Stanley and Barclays plans, although not directly comparable because of their different investment terms, offer two different defensive strategies.
An investor or adviser must decide whether the arguably higher market risk and slightly lower potential return of the Barclays plan are offset by the stronger counterparty and shorter investment term.
A more straight-forward growth plan is the Legal & General Growth Plan 6, which offers a fixed return of 60% after five years provided the FTSE 100 index is at or above its initial level. Capital protection is provided by a 50% end-of-term barrier, and the counterparty is Abbey National Treasury Services (Santander UK), rated A+ by Standard & Poor’s.
One option would be to use two different defensive plans within a portfolio, giving counterparty diversification while also helping capital gains tax planning if, as with the Barclays and Morgan Stanley plans, potential gains fall into different tax years.