Autocall products are increasingly popular with investors, advisers and product providers and should be judged on investors’ comfort, not on missed opportunities. Autocalls, also known as kick-out plans, have captured a large part of the structured product market in recent years. Product providers use them to offer higher payoffs than other SPs that automatically run to a full term. Advisers are using them to generate double-digit returns and provide portfolio diversification. Autocalls pay out a defined return providing a predefined event takes place. A simple FTSE-based product may offer 10% per annum if the index rises by a set amount from its initial starting point. If the trigger event occurs, the plan terminates early and returns investor cash plus the offered coupon. Should the trigger not occur, the plan keeps going to subsequent trigger anniversaries until kick-out conditions are met, rolling up coupons as it goes. If the plan reaches maturity, it pays out the cumulative coupon and returns the initial investment.
Many current products are based on single index structures that kick out if the market is flat or higher than its strike rate on each anniversary. Even if plans do not kick out, investors should remember they have not lost an annual coupon, merely rolled it up.
Investors have been using autocalls to diversify their portfolios. The products sit alongside other low risk products such as property funds. Many investors buy a variety of autocalls expecting them to mature at different dates. They are also mixed with ordinary structured products that reach their full maturity. In that way, investors can expect staggered capital gains, allowing them to plan their usage of the CGT tax allowances.
The common ‘flat or higher’ trigger should be seen as a point of comfort, rather than a missed opportunity if markets rally substantially by any autocall anniversary. Swap rates are low, meaning providers must use more of the initial capital to guarantee its complete return. The answer has been to introduce Capital At Risk structures, typically losing money if the FTSE index has fallen 50% or further from its strike level.
Combining multiple indices can also boost returns. A current single index product might offer 9%. One that depends on the performance of two indices should offer 11% or more. But multiple indices also increase the possibility that a structured product might not kick out early. A recent study shows how product designs must be manipulated to generate 19% coupons. Swap rates are low and spreads are coming in, leaving manufacturers with even less cash to buy the upside.
Six months ago, investors could expect autocall products to offer coupons around the 15% mark. Today, 8% is a more reasonable payoff on a single index product. Advisers and clients need to lower their expectations and compare these lower returns with what they can get in cash or other investments. Discretionary managers are searching for yield, but there is no consensus on market direction. In this environment, autocall products still work well.
With new issues offering lower coupons, fewer investors are opting to dive into rollover offers when their products kick out. Industry experts have noted that many investors simply need the cash to spend. Others are de-risking across their entire portfolios, not just pulling out of structured products.
Rolling over into the next available product should be selective. Successive issues will have different strike levels, event conditions and be facing very different market conditions.