Structured Products Delivering in Troubled Times

1. Structured ProductsDelivering in Troubled Times Clive Moore Managing Director Investment Design and Distribution

2. Investment Design and Distribution Established 2002 Consultancy with banks Private Client Managers Fund of Fund Managers Family Offices Some International International Principal Focus since 2008

3. Objectives • Learn about the history of Structured Products • Develop an understanding of how structured products work • Why they continue to deliver market-beating returns.

4. Warning!! • The following may make your head hurt a little • Don’t panic – you can get copies if you’re interested • Ask questions as we go • It won’t take long • Most people remember some of it • It’s actually easier than most people think

5. What is a Structured Product? • An investment that delivers returns in a different way to direct investment in the underlying asset. • Generating higher income instead of capital growth • Providing capital protection on ‘higher potential’ asset classes • Enhancing returns from modest market gains • Backing investment views in a concentrated way • Accessing hard-to-buy asset classes

6. Investor Attitude • Rate Fixation Legacy of Building Society retail funding requirement – they had to get so much money from retail investors before they could borrow any institutionally – so heavy rate competition (different to most other countries). • Short Termism British are eternal financial optimists, a better “rate” is just around the corner, so don’t like to “tie-up” their money too long. • Like to buy products they think they understand, rather than take advice – poor image of financial advisers, reluctance to discuss personal finances.

7. Popularity of Structured Products • Short and defined term • Often promoted with a “headline” rate • Good value (normally half the price of OEIC/UT) • Passive investment (not paying to underperform) • Variety of structures to suit particular needs • Terms are fixed at outset • Generally easy to understand and evaluate • Deliver returns in sideways markets

8. Massive Popularity with Wealthy Clients • Capital preservation is paramount • Preserve hard earned capital • Deliver easy to understand payoffs to investors who aren’t that interested in their portfolios • Clients looking for ‘cash plus’ return • Ability to deliver tailored solution for client needs • Focus on absolute return to retain client relationship

9. Counterparty Collapse Banks took on too much risk • Management focussed on sales – retail background led to desire to sell more loans (tins of beans) without credit considerations. • Counterparty issue hadn’t been clearly presented or understood • Nothing is risk-free • Advisers should pay attention and cover their rears! • If it looks too good to be true…

10. The Component Parts • “Cash” • Medium Term Notes/Zero Coupon Bonds. Debt issued by banks. Just like corporate bonds. Options normally embedded in the MTN. Counterparty issue! • Call options • The right (but not the obligation) to buy something at a predetermined price at a point in the future. • For example, the right to “buy” the FTSE 100 at 6000 points in 5 years time. • Put options • The right to sell something at a predetermined price at a point in the future. • For example, the right to “sell” the FTSE Index at 6000 points in 5 years time. Option normally embedded in structure.

11. Constructing Structured Products • Simple Growth Product: • 100p received from Investor: What gearing can be afforded? • Total margin of 5p to cover commission, marketing costs etc. • 6 year Zero costs 83p (6 year interest rates at 3.2%) • Leaves 100 - 83 - 5 = 12p to buy FTSE upside • 6 year FTSE Call option costing 20p • Gearing that can be offered = 12/20 = 60%

12. Building Blocks Simple Cash + Call E.G. Full capital return plus 60% FTSE growth Possible Bonus 100% 100% Call Options 100% Capital Return Charges Cash (MTNs) Provides Capital Return

13. Constructing Structured Products • Income Plan: • 100p received from Investor: What income can be afforded? • Total margin of 5p to cover commission, marketing costs etc. • 5 year Zero costs 85.5p • 1% income for 5 years costs 4.6p • So annual income of 7% costs 32.2p • So cost is 122.7p! • Sell 5 year FTSE 100 Put Option = 22.7p (lose 1:1 at maturity if Index ever below 50% of start value)

14. Building Blocks Cash minus Put E.G. 7% income each year, but lose 1 for 1 if Index lower Variable Capital Return Max 100% Put Option Premium 100% Max 100% Charges Cash (MTNs) Provides Capital Return and Income 5 x 7% Income

15. Features • Capital Protection • ‘Soft’ protection – as long as the worst Index has never been below 50% of its start value. • Check barrier level – is 60% a 40% drop or 60% drop? • American option = below 50% at any point. • European option = below 50% at maturity. • Early Kick-Outs • Early maturity with bonus if certain levels achieved. • Auto-call products, single or multiple underlying. • Coupon Counter/Podium payoff – income/growth hybrid.

16. Features • Stock Baskets • Returns linked to a basket of stocks/indices/commodities can give more diversification. • Remember, single shares can collapse completely, but indices never die – they just change constituents. • Counterparty Risk • ‘Riskier’ banks will pay higher returns (better looking products, wider margins). • Think of your excuse in case things go wrong. • Always ask – you should always be told. • Always Ask • Why is it different to everything else? • Make sure you understand the payoff in different scenarios. • Complexity may not be a bad thing, but check.

17. Why the Bad Reputation • Bad news makes a good headline. • Compensation culture – everyone’s a victim if there’s money in it. • PR from “vested interest groups” – Threat to traditional funds. • “I thought it was guaranteed” - Well pay attention can’t you read! • Execution only sales Should have spoken to an adviser, or bought a product you understood! • Products “sexed up” to look better than they were. • Counterparty issue not clearly highlighted. • Some providers too greedy – Inappropriate counterparties used.

18. Investor Emotion Index Good to outperform, but better not to underperform

19. Investment Backdrop Developed equity markets lagging – particularly UK Changes in capitalism • Shares were owned by people with a vested interest in their long term performance (company pension funds etc.) • Shares now owned by Fund Managers – interest only in relative performance • Fund manager income from stock-lending (which also encourages downward speculation) • Focus on attracting new investments. 10 year FTSE flat – CEO remuneration up 400%*!! • Too many snouts in the trough. • *Source Manifest MM&K

20. 10 Year Fund Performance Source: Morningstar 16th September 2011

21. Simplicity Leads to Success Product should be understandable in 2 paragraphs Remember, most investors are used to building society savings accounts Best to use recognisable underlyings Everyone likes a headline rate

22. The IDAD Difference How have the IDAD notes performed so far?

23. Structured Products Delivering in Troubled Times Details of our current offers are available on our website – www.idad.biz Or contact our IDAD Sales contact Or email: enquiries@idad.biz

24. Structured Products Delivering in Troubled Times Clive Moore Managing Director Investment Design and Distribution