In 2011, the kick out plan proved to be one of the most popular investments and this popularity has continued to rise. We take a look at some of the reasons that are driving this ongoing interest, and review our selection of what the market has to offer.
How they work – a quick recap
The Kick Out plan, or autocall to give it the correct investment term, is a market-linked investment which can automatically mature early or ‘kick out’, returning the original capital along with any stated returns. The early maturity can normally occur from the first anniversary and then every year thereafter and is dependent on pre-determined market conditions being achieved, for example, the FTSE being higher than the value at the start of the plan.
The other feature of Kick Out plans, common to many structured investments, is the inclusion of what is known as conditional capital protection. This is normally dependent on the underlying index not falling below a certain threshold, normally 50% of the starting value of the index.
An attractive balance
The investor has the benefit of knowing at outset the conditions that need to be met in order to provide the stated returns. Therefore, not only are the plans relatively simple to understand, but they also offer a defined return for a defined level of risk.
The combination of the potential for high returns and conditional capital protection give a well balanced investment, which can look attractive when compared with the more commonplace investment funds that put your capital at risk on an ongoing basis and offer variable returns.
Invest in the FTSE
The underlying asset to which these plans are linked to is important since it is the future movements of this index which determine what happens to your investment.
Most of the plans we list in our investment section use the FTSE 100 as the underlying index. This is widely recognised as the proxy benchmark for most investment managers and the historical volatility is familiar to many investors. The ability to review the rise and falls of the FTSE over more than 25 years offers the investor some context as to how high and how frequent the falls and rises have been.
The potential for high yields – up to 13%
We take a look at three investments currently available, Investec’s Enhanced Kick Out Plan, Morgan Stanley’s Defensive Bonus Plan and Legal & General’s Early Bonus Plan. Investec lead the way in terms of headline return with the potential for an annual return of 13% whilst Morgan Stanley offers 9.5% and Legal & General 9%.
So what are the reasons for such a range of potential returns and what are the differences to consider between these plans?
When can a kick out occur?
One of the reasons that Investec is able to offer such a high yield when compared to other plans is that the ability to kick out only occurs in years 1 to 4. If the plan does not kick out by year 4, the year 5 return is 1.2 (120%) times any rise in the FTSE, which is subject to averaging over the final six months of the plan. Although the probability of these plans kicking out is highest in first few years, this is different to all other plans which offer you the opportunity to kick out in the final year as well.
Legal & General’s Early Bonus Plan can kick out in any year from year one to the final year. Past performance analysis carried out by Future Value Consultants, an independent research consultancy specialising in structured products, shows that the probability of a kick out occurring is around 86%, of which 70% occur in years 1 or 2. Morgan Stanley’s plan can only kick out from year 2 onwards, with an 88% chance of kicking out in years 2 to 6.
Counterparty – its effect on returns
Another reason why Investec is able to offer such a high potential return is they are also the counterparty to the investment. Each Kick Out plan has to rely not only on the performance of the index before paying out, but also on the ability of the counterparty to pay since you are in effect buying securities issued by them. This brings into play the credit worthiness of the counterparty, with the lower rated having to offer a higher level of return as the market considers them more likely to default.
Moody’s is one of the three main credit ratings agencies to offer a rating for all three counterparties concerned here. As you would imagine, Investec has the lowest rating of the three investment plans with a Baa3 rating. The Baa rating means that their long term credit obligations are subject to moderate credit risk and considered medium grade and as such may possess certain speculative characteristics. The ‘3’ means that they are at the lower end of this rating scale.
The other two providers, Morgan Stanley and Santander (the counterparty for the L&G plan) both have an A2 rating. The A is the level above Baa and means their obligations are considered upper-medium grade and are subject to low credit risk, with the 2 denoting they are in the middle of this rating scale. Morgan Stanley’s rating is under review with a possible downgrade in the near term whilst Santander’s has a negative outlook meaning a possible downgrade in the medium term.
Reducing risk – collateralisation
To offer an alternative for those investors who do not consider the increase to the potential yield is worth the additional counterparty risk, Investec also offers a collateralised version of the plan, known as the UK 5 option. This spreads the risk of your investment equally (i.e. 20% each) among HSBC, Nationwide, Santander, RBS and Lloyds and has the effect of reducing the potential yield from 13% to 10.5%. The lack of a potential kick out in the final year remains a feature with this version of the plan.
Returns even if the FTSE falls by 10%
The Morgan Stanley plan stands out from the other two in that the plan can kick out from year 2 onwards, even if the FTSE has fallen by up to 10% from its value at the start of the plan. This is why the probability of it kicking out, even though it can only do so from year 2 onwards, is higher than the other two plans.
Conditional capital protection
One final point to note is that all three plans contain what is known as conditional capital protection. This means that your original capital will be returned provided the FTSE has not fallen by more than 50%. However, there are differences from plan to plan in how this is measured.
Investec tests this throughout the investment term by taking the closing value of the FTSE on each business day. If the FTSE falls below this barrier and is also below the starting value at the end of the investment term (taken as the average of the closing values over the last six months), you initial investment will be reduced by 1% for every 1% fall. If the plan kicks out or remains until the end of the 5 years and is still higher than the original value, you will still receive at least your original capital back.
Both the Morgan Stanley and Legal & General plans test the 50% barrier on the final day of the investment term only and are therefore the more attractive options in this respect.
Although all three of the investments covered fall within the Kick Out category, there are a number of differences between them and, depending on which particular features are important to you, these will shape your view on which is the better option.
Investec offers the highest potential return but has the lowest credit rating and offers a different return in the final year. Legal & General offers the lowest return but a higher credit rating, whilst Morgan Stanley are at the lower end in terms of growth potential but have a reasonable credit rating and the plan will kick out even if the FTSE falls by 10%.
Although the opportunity to receive the headline yield is a strong motivator, in following the investment principle of risk v reward it is wise to dig deeper into the underlying features of the plan before proceeding.
Compare kick out investments »
No news, feature article or comment should be seen as a personal recommendation to invest.
Different types of investment carry different levels of risk and may not be suitable for all investors.
Some structured investment plans are not capital protected and there may be the risk of losing some or all of your initial investment. There is also 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 which case you may not be entitled to compensation from the Financial Services Compensation Scheme (FSCS). In addition, you may not get back the full amount invested if the plan is not held for the full term. The past performance of the FTSE 100 Index is not a guide to its future performance.
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.
© Fair Investment Company Limited