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Rollover? – Defined Returns and Investment Strategy

It’s looking like a rollover, and I’m not talking about the Lottery. Our Barclays defined return product has its first anniversary date next week.

For a number of years we have been investing in Defined Returns products. The products return a defined rate given an underlying index is above a specific level on the anniversary of the product – known as the ‘kick out’ date. If the product doesn’t ‘kick out’ on the first anniversary it rolls over to the next, and so on, for a maximum of six years. If you want to find out more about the products you should check out a great article Neal wrote for our October edition of Equinox which explains these products in a little more detail here.

Of the ten products we have invested in to date, each one has kicked out after one year. We have then generally used the proceeds to purchase a new product, albeit not always when we felt a better entry point and rate could be achieved by holding off for a market dip.

Our analysis of historic market returns has shown us that if you could have bought one of these products at any time since the FTSE 100 began, c77% of the time the kick out would happen after the first year. A further c10% would ‘kick out’ at the end of the second year. Given these statistics it was about time that one of our products rolled over.

I write this a week before the anniversary date and with the kick out level set at 6,742, we are some 400 points adrift - or we need the FTSE 100 to gain 6.4% in the next week. This is not unheard of as, in the history of the FTSE 100, it has returned this much in a week 50 times before, that’s 0.6% of all weekly periods, and the last time this happened was at the beginning of October.

Okay, so in all honesty, it’s a long shot for the product to kick out next week but is it really the end of the world? We continue to hold the product and can still purchase more of the same at close to the initial price we paid for the product if we wish to do so. If it kicks out at the end of the second year, holders will receive twice the rate of the first year – it is almost beginning to sound like a lottery rollover!

The Barclays product specifically has a rate of return of 9.15% pa (simple) so a kick out on the second anniversary would mean an 18.3% return on capital - the FTSE only has to rise 6.4% in order to achieve this, which I think sounds like a good deal! As time moves on if it becomes more likely the defined return will kick out, the price will go up and the actual return an investor receives would go down if they bought in at that point.

Obviously this is something we are keeping close tabs on and should we feel price is not attractive, or there is a better option than continuing to hold the product into the second year or beyond, we would look to take advantage. We don’t need to wait for a kick out date to sell the product if the price was right.

By knowing the potential returns generated by a defined return product and understanding the risks allows us to make a considered investment decision – at the current price we will continue to hold the Barclays product and purchase it for new clients.

The information provided through the Equilibrium website is based on our opinion and is for general information purposes only. It is not, and should not be construed as financial advice.

The content contained in this blog represents the opinions of Equilibrium investment management team. The commentary in this blog in no way constitutes a solicitation of investment advice. It should not be relied upon in making investment decisions and is intended solely for the entertainment of the reader.