How to invest in the FTSE in the current climate

How to invest in the FTSE in the current climate

17 September 2013 / by Oliver Roylance-Smith

Apart from a surge past the 6,800 mark towards the middle of May, the FTSE 100 Index has remained between 6,000 and 6,600 points for almost the entire year. With the Index continuing to hover within this narrow range, it is interesting to find out how investors as well as investment providers are reacting to the current climate. We therefore take a look at the investment dilemma faced by those considering the impact future performance of this important benchmark may have, as well as review some of the options that both savers and investors are considering right now.

The FTSE 100

For several years now ultra-low interest rates and expanding central bank balance sheets have been nudging both savers and investors toward equities. With the record low yields currently available from traditional savings products, perhaps more of us are now having to consider how best to use our capital than ever before. As the most recognised and closely followed stock market index in the UK, the FTSE 100 (the FTSE) is often one of the first considerations for those prepared to put their capital at risk in the hunt for potentially higher returns.

As a result, movements in the FTSE can not only have a profound impact on our overall investment performance, but also our attitudes towards investing and the different types of investments available.

Past performance

Regardless of your savings and investment experience to date, you would be hard pushed to find someone that has not been directly affected by the global financial crisis that has unravelled in recent years. Along with all other major stock markets, the benchmark index of UK blue-chip shares has had its ups and downs. The following table details the range in opening values of the FTSE for the 12 months between mid Septembers over the last six years:Timeframe

 
Lowest level
Highest level
Range (points)
Sep 2012 to Sep 2013
5605.6
6840.3
1234.7
Sep 2011 to Sep 2012
4944.4
5965.6
1021.2
Sep 2010 to Sep 2011
5007.2
6091.3
1084.1
Sep 2009 to Sep 2010
4805.8
5825.0
1019.2
Sep 2008 to Sep 2009
3512.1
5311.3
1799.2
Sep 2007 to Sep 2008
5150.6
6730.7
1580.1

Past performance is not a guide to future performance.

As you can see, in each of the four previous 12 month periods the FTSE moved within a range of more than 1,000 points, with far wider ranges during the more volatile years that cover the 2008/09 stock market crash. Of further note is how high by comparison with preceding years the ‘Lowest opening level’ was for the latest 12 month period, also bearing in mind that the FTSE has never broken through the 7,000 point barrier.

The recent bull run

Since mid November 2012, there has been a surge forward in the FTSE 100 Index that has taken the shape of a classic (and welcome) bull run, as the UK joined stock markets around the world in rising close to or even surpassing their record highs.

However, we have also commented previously that this was an unusual period and that we were experiencing a very strange bull market indeed, (link) with the overriding feeling amongst many investors not being one of excitement, but rather awaiting the arrival of the next major setback.

Summer blues

Where are we now? Well, the summer months have been largely uneventful with the current levels of the FTSE broadly as they were in mid July. So although this latest bull run may appear to be stuttering, perhaps more importantly it is no clearer whether we on the edge of that set back which so many investors would be forgiven for feeling could happen at any moment.

Equity sectors, however, have found this period rather more difficult with all Investment Management Association (IMA) sectors losing money in August except those focusing on UK smaller companies where the average fund made 3.14%. These losses are mainly due to concerns the US Federal Reserve would begin to ‘taper’ its monetary stimulus by paring back quantitative easing.
Compare UK Smaller Companies funds »

The investment dilemma

We should all understand that past performance is not a guide to what will happen in the future and it is also important to remember that different investment timeframes can produce very different results. The performance figures above also show just how much the FTSE can change over a relatively short period and so for investments which broadly follow the value of the FTSE on a daily basis, the values at the start and end of our investment can have a huge impact on our overall returns.

If you are fortunate enough to go in at or about the lowest point then you are potentially in good shape. However, you still need to make the right call as to when to come out of the market, a seemingly difficult task that can often fly in the face of investor emotion. Certainly getting both of these right based on anything other than chance would appear to be extremely difficult, let alone being successful time after time.

Defined return, defined risk

It is exactly these difficulties that arise when investing in any open ended investment, whether it be tracking an index or part of a wider portfolio. Another alternative is to use investments which provide a defined level of return for a defined level of risk.

These are normally fixed term investments of 5 or 6 years in length where you know right at the outset, prior to investing, what needs to happen in order to produce the stated returns. In terms of assessing how the investment may or may not fit your needs, you are therefore well positioned.

Are you a bull or a bear?

The FTSE 100 Index is currently hovering around the 6,600 mark and although it has had a few minor blips recently, has treaded water for much of the last few months and is still up considerably over the past year. However, for investors looking to make new investments or transfer existing investments, having the FTSE remain at historically high levels raises the question whether now is the right time to invest or not.

As things stand, any change in central bank conditions could have the potential to create a markedly different investment environment and arguably investors could expect to see increased levels of volatility with plenty more bumps along the way. Other than that, the question to ask yourself is which way the market might go from here – are you a bull or a bear? Only then can you consider investments which reflect this view.

‘Kick Out’ investments remain popular

One particular type of fixed term investment which seems to be popular in all kinds of market conditions is the autocall investment or ‘kick out’ as it is more commonly known. These investments have the ability to mature early, normally from year 1, thereby offering the potential for attractive returns after a relatively short period of time.

Whether the plan kicks out in the future is usually dependent on the FTSE being at a particular level at a particular date, which is then normally referenced to its level at the start of the investment. If it does not meet the required levels throughout the investment term, no returns will be paid and your capital may be at risk. The early maturity feature which is unique to these plans brings a new element to the investment opportunity and means that although your longer term view of the FTSE is important, so is your view on the potential for the FTSE year on year.

FTSE remains relatively flat - just a single point higher

This type of investment has remained popular since if the FTSE stays relatively flat but is just one point higher at the required date, these investments can mature, some of them providing double digit returns. In this context, the ability to beat the market is obviously appealing and which is why even when the FTSE is at historically high levels, kick out investments can also prove to be a popular strategy.

If you think the FTSE will remain relatively flat in the coming years then the Enhanced Kick-Out Plan from Investec may be of interest. This investment offers the potential to mature early and return 7.75% for each year the plan has been in place (not compounded). The plan has a 6 year investment term but will mature early if the FTSE 100 finishes higher than its starting value at the end of each year, from year one onwards. This investment could therefore provide competitive returns even if the FTSE has only gone up a little. If the FTSE fails to be higher at the end of each year, no returns will be paid.

Defensive options – the best of both worlds?

One of our most popular kick out investments at present is the Defensive Kick Out Plan from Morgan Stanley since it combines the potential for high returns with the provision of some protection against a slightly falling market.

This protection comes in the form of a reduced FTSE level required for the investment to mature early, although the investment can only kick out from year 2 onwards. A new issue has just been launched with a competitive headline return of 8.75% as well as a 95% barrier for measuring against the starting level of the FTSE. This investment could therefore have the following outcomes:

-    the FTSE has risen 30% in 2 year’s time, you receive 17.5%;
-    the FTSE has risen 10% in 2 year’s time, you receive 17.5%;
-    the FTSE is at the same level in 2 year’s time, you receive 17.5%;
-    the FTSE has fallen almost 5% in 3 year’s time, you receive 17.5%.

Another example of a defensive investment is the FTSE Step Down Autocall Plan from Start Point Investments (BNP Paribas). This plan will return 7.2%* for each year the plan has been in place (not compounded) provided the FTSE is higher than a particular level at the end of each year (from year 2 onwards). The defensive part of the investment refers to the level falling by 3% each year (from year 2), falling to 80% of its starting value in the final year.

Finally, for those prepared to tie their capital up for six years, Morgan Stanley has also just launched a new version of their FTSE Defensive Digital Growth Plan which offers a fixed return of 60% at the end of the investment term provided the FTSE has not fallen by more than 15% from its value at the start of the plan.

With all of the above defensive investments, if no return is generated your capital will be at risk if the FTSE 100 has fallen by more than 50% during the investment term and has not recovered to its starting value. In this case your initial capital will be reduced by 1% for each 1% fall.

Blue chip companies lead the way

One further unusual element to the recent bull market is that it has been led by the traditional ‘defensive’ stocks. These big blue chip, dividend paying shares are often those that underperform in a rising market but do well in more difficult times, however this was not the case. If the economy does pick up you could reasonably expect the cyclical stocks to catch up with the more defensive shares. But whether this happens or not, if you take a medium term view and consider that the larger blue chip companies will continue to offer the potential for attractive returns, then the UK Giants Selector Plan from Morgan Stanley might be worth a closer look.

This investment offers a return linked to the best performing 11 shares from the 20 largest FTSE 100 companies. Commenting on this investment, head of savings and investments at Fair Investment Company Limited, Oliver Roylance-Smith, said: “The potential for high returns is one of the main attractions of investing in the stock market, but the opportunity to access the growth potential of only the best-performing largest UK companies might be even more appealing for those investors who consider these companies will lead the way out of this difficult economic environment”. 

Some protection from a falling market

As already mentioned, in addition to the potential returns on offer the other element of your overall return is what happens to your original investment, and you should always remember to balance any potential upside with the fact that your capital is at risk. Within all of the above investments, it is both your returns as well as a return of initial capital that is dependent on the performance of the FTSE 100, with the latter having some protection from a falling market built into each plan - known as conditional capital protection.

For all of the above investments except the UK Giants Plan, your capital is at risk if the FTSE falls by more than 50% during the investment term and also finishes below the level required for the plan to produce a return. In this scenario your initial capital will be reduced by 1% for each 1% fall.  The UK Giants Plan includes the same 50% barrier but this is measured on the last day of the investment only. As such, none of these investments are fully capital protected and therefore should only be considered if you are prepared to lose some or all of your initial investment.

Meeting investor needs

The kick out is then a flexible type of investment and the various features which combine to make up the plan can be adapted to the prevailing investment climate providing the potential for an attractive proposition in a wide variety of market conditions.

The fixed term investment with its defined return for a defined level of risk can also be designed to offer the potential for competitive returns whilst still offering some capital protection against a falling market. So depending on your view on what will happen to the FTSE in the coming years, there should be something to meet your needs.

Compare kick out investments »

Compare defensive kick out investments »

Compare other growth investments »


No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular investment. If you are at all unsure of the suitability of a particular investment, both in respect of its objectives and its risk profile, you should seek independent financial advice. Tax treatment depends on your individual circumstances and may change. Make sure you check whether any charges apply prior to transferring any existing investment.

These are structured investment plans that are not capital protected and are not covered by the Financial Services Compensation Scheme (FSCS) for default alone. There is a risk of losing some or all of your initial investment. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index or any shares listed in the Index is not a guide to their future performance.

© Fair Investment Company Limited