US President Donald Trump’s regular Twitter outbursts imposing or threatening to impose new tariffs on Chinese goods, have reminded investors of just how vulnerable emerging markets are to what happens between the US and China.
South African investors are acutely aware of this and threats closer to home – notably the fiscal and economic impacts of the increased assistance given to Eskom by the government.
While the clarion call to diversify one’s investments globally is as loud as ever, investors are also understandably uneasy about switching into developed markets at such a juncture, particularly the largest of them all, the US.
Bears point out that in the US, the flattening and inverting of the yield curve (when the gap in yields between shorter dated and longer dated bonds narrows and then becomes negative) is seen by many as a harbinger of a recession. They add that this could be triggered by a further rise in hostilities in the Sino-US trade war.
Europe, the other important developed market, has seen its leading economic indicators declining this year. Like emerging markets, Europe’s economic prospects are heavily linked to those of China, through its export sector. Bears add that government policy uncertainty, driven by populist leaders in key economies – of which trade wars are a by-product – is also on the rise, increasing the chances of policy mistakes.
Bulls counter this by pointing out that the world’s leading developed market central banks – and many emerging market central banks – have switched to more accommodative policies. This is in response to weaker economic activity and the absence of inflationary pressure in all of the world’s major economies.
This they argue, should bode well for equity markets – despite the US currently enjoying its longest expansion in history (121 months as of July). Jobless claims, which are also used by market analysts to assess the likelihood of recession, are at multi-decade lows – indicating no recession on the immediate horizon.
So how does the average investor reconcile these two different views? Is it possible to participate in any further upside in developed markets while enjoying downside protection, in case the bear market scenario plays out?
One answer has been to look at the world of structured products. Structured products provide a useful tool for investors to take a particular view on a market or index for a defined period, while enjoying a degree of downside protection should the view not materialise.
Structured products have an excellent track record of delivering performance while protecting capital. Melissa Dyer CFP, Managing Director of Harbour Wealth, says: “We have seen structured products perform increasingly well as they have become more responsive to market opportunities and simpler in their structure.”
“Over the past few months, our investors have received returns from Structured Products of between 40% (Investec USD S&P 500 Digital Plus) to 76% (Investec FTSE 100 Autocall) over a 3.5-year investment period, with their capital protected. These products don’t replace your traditional investments, they just enhance and diversify. Investors have also responded positively to the increased transparency and easy accessibility of structured products. As a financial adviser, having an investment that has some level of capital protection, as well as geared upside, provides a wonderful alternative when structuring clients’ investments in these difficult market conditions.”
Investec’s Brian McMillan says an analysis of their structured products over the last 10 years reveals that 93% of issues have returned a profit for investors, with an average annualised return in rands of 10.6% versus 6.3% for the underlying indices with none having incurred losses.
“The growth in popularity of the asset class points to the fact that it’s satisfying a need in the investor community. Investors are looking beyond simple strategies that just track indices up or down, but for those where they can combine a view on a particular market index with capital protection – especially important in volatile times,” says McMillan.
“And through structured products investors can take a view on most of the world’s leading stock indices, in different currencies. This sort of choice and availability is especially attractive for investors with specific investment goals in mind, as well as in post-retirement,” adds Dyer.
McMillan notes that in Investec’s case, the value of structured products has grown by an average annual rate of 17% over the last 10 years, which compares well against domestic market returns.
McMillan says investors should consider a number of elements when choosing a structured product, including: the underlying index referenced, the currency in which returns are calculated, the product term (when it matures), the upside gearing and the capital protection provided.
“It’s important to run through the different possible market outcomes and their impact on your returns, in the currency in which the product is issued – which may differ from the base currency in which the underlying index is listed,” he explains. “And make sure the product is issued by a reputable, well-capitalised institution.”
McMillan emphasises that investors should consider each structured product as part of one’s broader investment strategy, in consultation with a financial adviser.