‘10% income and 100% capital protection’ – what an attention grabber in a volatile market.
‘History doesn’t repeat itself, but it does sometimes rhyme’.
You can’t help but think that the marketing companies of the life insurance industry know this, and are keen to slowly make you submit, by hitting you with a small twig every hour for a long time. So I read a recent email offering a structured sales plan!
A ‘structured contract’ is the technical term, but you will see them marketed very much as above. The small print will then explain what the potential risk might be to both that income and the capital protection. I am not a lover of such arrangements and that is well quoted, but I must consider that every month I see numerous offerings, so I can only assume people are buying them.
The plan I looked at was a fair enough offering by blue sky asset management. It was their protected income plan, and I couldn’t help but notice a number of issues with it which may go unnoticed by the untrained eye. It offers 10% income plus capital protection as long as one of five banking sector stocks doesn’t fall by over 65% and return to its original capital value.
I studied the salesmail which explained the ‘income’ and I then read the brochure and couldn’t tie them up. You see, income to the average person is building society returns or the coupon from fixed interest investments. Income is what you receive irrespective of capital movements. This is not obvious at all from the documentation.
The brochure simply explains the income is calculated by giving you back 10% of the original capital. The email however, goes at length to explain that they are ‘enhancing the average dividend yield of the portfolio (nearly doubling it to 10%)’.
Apparently it is designed to take advantage of the ‘indiscriminate fall out in the banking sector in 2007’ Surely indiscriminate means haphazard, unsystematic or random.
What can possibly be random about devaluing overvalued worried stocks? The banking sector has taken a battering which is very justifiable. One could easily argue that the true impact is yet to come:
How many loans have banks agreed for customers on a self certificated basis where the customer doesn’t have that income? How many loans are coming out of a fixed rate now and into the standard variable rate? Who will be left with the bad debt?
The email points to the fact that the downturn appears to be overplayed in banking stocks. If that was the case the customer should buy the basket of five banking shares, enjoy the 7.38% average yield they currently offer, as well as the capital growth in the stocks – or am I missing something?
My main issues are that the risk may well be played down in the document. On the face of it, the potential for return and reward do seem fair, but whilst I am not a financials sector stock analyst, few would be betting on banks and what demons may be in their treasure chest.
The brochure states that to understand the risk you must understand the probability of the plan or any individual stock dropping 65%. Who would bet this would happen? What’s the probability? Who is qualified to know?
The danger here is that the customer could get carried away with the definite income and the capital ‘protection’, and mix up the risk of a volatility range of an index, rather than an individual share. No-one expected Northern Rock to drop by 10% did they? It had a 52 week high of 1157 and a 52 week low of 52.50 – a fall of 95.5%.
In some ways the risk is increased, as modern portfolio theory is inverted, where the performance of the ‘capital protection’ is based on one ‘worst performing share’ as opposed to a spread.
In relation to products and to quote Mark Twain again, ‘the trouble ain’t that there too many fools, it’s just that the lightning isn’t distributed right’
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