Article July 20, 2020

“Stay alert” – the power of the full investment tool kit

The potential for larger than normal swings in investment markets in either direction is substantial.

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The potential for larger than normal swings in investment markets in either direction is substantial. So it’s important to stay alert for opportunities that provide a positive return outcome in a wide range of market scenarios. As the saying goes “an individual is only as good as their tools” so make sure you have access to a wide range of innovative investment tools. Structured equity could be one you’re missing out on.

We have experienced the largest economic shock since World War II, with the potential for a long and uneven recovery. On the other hand, we have seen huge fiscal and monetary stimulus that continues to be expanded and has had a very powerful impact on markets over the second quarter of 2020. The COVID-19 outbreak led markets down 20-30% in February and March, the quickest equity selloff in history, followed by a startling recovery since. Protecting assets in times of market stress is vital. But the ability and conviction to act quickly to take advantage of investment opportunities that appear in times of stress is also important.

STRUCTURED EQUITY, A DERIVATIVE-BASED STRATEGY, ALLOWS INVESTORS TO SHAPE THE RETURN PROFILE OF THEIR EQUITY EXPOSURE QUICKLY AND CHEAPLY.

In March, we wrote about using structured equity to take advantage of the significant market selloff. For those that can use it, structured equity investments of this nature can be tailored to allow investors to remain invested in equity, should markets continue to move upwards, whilst providing explicit protection should markets fall significantly again. We often use structured equity in this way as part of a long-term equity strategy. But increased volatility in equity markets (a key driver of structured equity pricing), provides some especially attractive return profiles for those investors ready to act.

AN IMPROVEMENT IN PRICING HAS ALSO SEEN A RESURGENCE IN THE ATTRACTIVENESS OF ‘ALTERNATIVE’ STRUCTURED EQUITY STRATEGIES, UNCORRELATED TO EQUITY MARKETS.

We were recently able to achieve structures that provide a 5-6% return above cash should the value of the US equity market[1] remain within a range of +/-30% in 12 months (see return profile below). The investment then starts to participate in market falls beyond 30%, but importantly remains substantially ahead of a direct investment in the US equity market[1]. The investment returns nothing (in excess of the investment amount) should the equity market rise beyond 35% over the year, but such a scenario would be expected to be strongly supportive of most traditional asset classes in the portfolio.

This ‘Alternative’ style of structure provides cheap diversification away from equity, in a way that’s quick to implement. Unlike traditional Alternative investments, it doesn’t rely on manager skill, as the exact return profile is known from the outset. It can also contribute towards a scheme’s liability hedging when the derivatives are backed by government bonds.

GIVEN HOW QUICKLY CONDITIONS HAVE BEEN CHANGING, SUCH ATTRACTIVE PRICING IN THESE MORE NICHE OPPORTUNITIES HAS ONLY BEEN AVAILABLE FLEETINGLY, DURING THE PERIOD OF ELEVATED VOLATILITY.

The below chart shows how pricing has varied over the last 3 years. Here we show the “return range width” over which a return of Cash+5% is provided after 1 year. For example, the average available return range width over the last 3 years is around 20%. This means the Cash+5% return is only provided if the US equity market[1] ends the 1-year term between -10% and +10% relative to the value of the equity market at the point of trade.

As shown above, the pricing improvement due to the recent spike in equity volatility allowed us to achieve a return range of c.60% (i.e. +/-30% relative to the level at the outset) and was very short-lived. Having an in-house derivatives team with over 15 years of experience in implementing such strategies has been pivotal. As a result, we were able to implement the above solution for all of our delegated clients (and many non-delegated clients where it was appropriate) – clients with total assets spanning from £1m to £2bn in size.

Time-sensitive ideas such as these can really add to the return potential of your portfolio. But you need to work with an investment manager who can access them. Although pricing isn’t currently as attractive as it was in April, it’s still better than it has been in the last few years and could pick up again should we see further volatility. If you’d like to hear more about how your scheme could benefit from using structured equity please get in touch.

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[1] S&P500 Index

This article constitutes a financial promotion and has been issued and approved by River and Mercantile Solutions, a division of River and Mercantile Investments Limited which is authorised and regulated in the United Kingdom by the Financial Conduct Authority and is a subsidiary of River and Mercantile Group Plc (registered in England and Wales No. 04035248).
Please note that all material within this communication is produced by River and Mercantile Solutions and is directed at, and intended for, the consideration of Professional clients only. This document constitutes a financial promotion within the meaning of the Financial Services and Markets Act 2000 ("FSMA"). Retail clients must not place any reliance upon the contents.
The value of investments and any income generated may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. Past performance is not a guide to future performance. Changes in exchange rates may have an adverse effect on the value, price or income of investments.
Registered office: 30 Coleman Street, London, EC2R 5AL
Registered in England and Wales No. 3359127
FCA Registration No. 195028
A River and Mercantile Group company

ES R&M UK High Alpha Fund

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