Lowes Autocall Review 2022 Update

Structured Product Autocall Review 2022 Update

A review of the evolution of the UK Retail Structured Product, Autocall sector, including performance review of the first 1,250 FTSE 100 linked, capital at risk autocalls to reach maturity.

Contents

Structured Product Autocall Review 2022................................................................................................3

Headline Performance Data...........................................................................................................................3

Autocall Shape Variations................................................................................................................................5

Capital Protection Barriers..............................................................................................................................6

Maximum Durations...........................................................................................................................................6

Counterparties......................................................................................................................................................7

FTSE 100 Autocall Maturity Analysis...........................................................................................................8

About Lowes Financial Management & Structured Products............................................................9

2

Structured Product Autocall Review 2022

A review of the evolution of the UK Retail Structured Product autocall sector, including a performance review of the first 1,250 FTSE 100 linked capital-at-risk autocalls to reach maturity.

Headline performance data • 1250 FTSE 100 linked capital-at-risk autocall products have matured in the UK retails space to date* • All but eight of these plans successfully matured with a gain • The average annualised return of the 1250 maturities was 7.9% • The typical duration was two years • It remains that no maturing FTSE 100 linked capital-at-risk autocall plan has failed to reward investors with a gain since April 2013 - representing almost a decade of consistent positive performance Structured products first appeared in the UK retail investment space in the early 1990’s as fixed term, equity linked growth products. Various income products followed, some of more questionable design, and in 2003 the first autocall, or ‘kick out’, contract was issued. Whilst the sector continued to be dominated by growth products for a number of years, the popularity of autocalls grew to the point that they are now the most common product offering. Whilst the sector has witnessed many variations on the theme, FTSE 100 linked, capital at risk autocalls have become the mainstay of the UK Independent Financial Advice distributed market. February 2022 witnessed the maturity of the 1,250th FTSE 100 linked capital at risk autocall in the UK retail market, and so we take this opportunity to review the evolution of the sector and the performance of the first 1,250 to reach maturity. Autocalls, which is the abbreviation of ‘automatically callable’ (aka kick-outs), deliver investors a defined equity-like return through limiting investment exposure to an underlying equity index, such as the FTSE 100 Index, whilst further building in a buffer of protection against falling markets. An autocallable product would be called prior to final maturity date if the reference asset is at, or above its initial level (or any other predetermined level) on a specified observation date. The investor would receive their investment capital plus a pre-determined premium (often referred to as a coupon) and the autocallable product is redeemed early. Autocallable products may be linked to individual or a basket of shares, stock market indices, commodities or other assets. The first autocallable structured product, Premier Asset Management’s FTSE 100 Growth Plan (Edition No. 8) was issued in May 2003. It offered an 8% simple return for each year it was in force and would mature on the first anniversary that the FTSE 100 index was above the level recorded at commencement. If it had not matured by the sixth anniversary and the FTSE had fallen by more than half during the term the investment would track the index. As it was, successful maturity was triggered on the first anniversary. By the end of the first decade of the 21st century, fourteen providers had issued 100 broadly similar contracts, almost half of which were issued in 2009. Over the following eleven years, 3,155 autocallable structured products were issued to the UK retail market, making them the dominant structured investment shape accounting for 59.12% of products issued in this period.

3

*Up to February 2022

The dominance of autocalls in the UK retail sector 2003 - 2021

Auto-Call / Kick-Out

Growth Product

Income Product

Autocall products, be it deposit based or capital-at-risk, have accounted for 49% of all products issued in the UK retail space since 2003. FTSE 100 only linked capital-at-risk plans are the most common product shape within the wider autocall subsector, making up over half (56.56%) of all autocalls issued.

FTSE 100 linked, capital at risk autocalls issued per year

250

200

150

100

50

0

2011

2017

2014

2013

2021

2012

2018

2015

2019

2016

2010

2007

2020

2003

2004

2008

2005

2009

2006

4

Autocall Shape Variations

Capital-at-risk FTSE linked autocalls can be subdivided into four main shapes: 1. At-the-money autocalls. Designed to mature on the first potential maturity date that the FTSE 100 Index is at, or above the strike level, this typically being the level recorded at commencement of the term.

3. Defensive autocalls. The opposite to hurdle contracts in that the maturity trigger is set at a level below the strike level. 4. Step-down autocalls. The maturity trigger for the first potential maturity date is set at a level which could be the same, or higher than the strike level, but if maturity does not occur then the maturity trigger reduces on subsequent anniversaries, albeit not necessarily on the next.

2. Hurdle autocalls. As with at-the-money contracts, but rather than the maturity trigger being the same as the strike level, it is at a higher level, requiring the index to grow in order to trigger a positive maturity.

Of these four shapes, the most common has been the at-the-money autocalls, accounting for 53.15% of all FTSE 100 linked capital-at-risk maturities, followed by the step down (32.85%), defensive (10.02%) and hurdle contracts (3.98%).

Prevalence of different shapes of FTSE 100 linked, capital-at-risk autocalls 2003 – 2021

At the money

Step Down

Defensive

Hurdle

5

Capital Protection Barriers

There have been two types of contingent capital protection barrier utilised in the sector: European and American. European Barriers are observed only at the very end of the maximum investment term and then, obviously only if the investment did not mature sooner. A 65% European barrier for example, protects capital from falls in the underlying of up to 35%. If the autocall does not mature positively and the underlying ends the term, say 34% lower, all of the original capital would be returned but if it was 36% lower, only 64% of capital would be returned. American Barriers are observed throughout the term and if they are breached, then there is effectively no barrier at the end of the term. For example: 60% American barrier, the underlying falls 40.1% in the early years, a positive maturity is not subsequently triggered and the underlying finishes the term below the strike level by any percentage. In this instance the loss will be in line with the fall over the term, no matter how small. Whilst all products issued early in the sector’s evolution utilised American barriers, these have been replaced to the extent that all products, bar two issued in 2021, now utilise the European variety. The two plans issued in 2021 that don’t utilise a European barrier in isolation, incorporate a combination of the two protection barrier types; if the European barrier is breached at the end of term, the loss is equivalent to a fixed percentage for each day the underlying was below the barrier during the term.

Maximum Durations

The maximum duration of an autocall only has a bearing if the investment does not call / mature before the final maturity date. Clearly, the longer the maximum duration and the more frequent the callable maturity dates, the greater the potential for the investment to mature with a gain. A longer duration also defers the ultimate loss determination date, which may prove beneficial in adverse market conditions. Over the previous decade we have been consistent in our advocacy of an extended maximum investment term for new issue autocall structured products. In our Retail Structured Product Review of the Sector 2010 – 2019 we outlined several crucial developments enjoyed by the sector, including the extended maximum investment term of capital-at-risk autocalls. By way of illustration, between 2010 and 2015 no capital-at-risk autocalls released into the sector had a maximum duration of over six years, whereas by 2019 80.74% of all new issues had a maximum duration of more than 6 years. However, over the last year there has been a significant re-emergence of autocall products being released into the UK retail space with reduced maximum investment terms of not just 6 years, but 5 years. The evolution of maximum durations and move to European barriers is shown below.

Maximum lengths of capital-at-risk autocall structured products

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

2017

Under 6 years 2014

2013

2021

2012

2018

2015

2019

6 years 2016

2020

Longer than 6 years

6

Prior to the market correction in 2020, these extended terms proved inconsequential. However, the market correction and infectious uncertainty arising from the Covid-19 pandemic is an example of a ‘Black Swan’ event that the introduction of the longer terms sought to overcome, by providing more opportunities for the investment to mature with a positive outcome. Whilst the market has recovered from the pandemic fall it is still fundamentally our view that common sense should prevail here; the longer a plan has to run, the greater the chance of positive maturity through recovery in the event of as market crash, whilst benefiting from snowballing coupons. Ultimately, we hope that no situation arises whereby short term autocalls are caught by adverse conditions to loss-making effect, but we will continue to advocate the obvious benefit of the extended maximum term not least because they provide very welcome peace of mind right when it is needed.

Counterparties

The ‘counterparty’ is the financial institution (typically a bank) that issues the securities from which the structured product is comprised. Whilst the product administrator and custodian facilitate and safeguard client money during the term of the investment, the return of invested capital is ultimately dependent on the continued solvency of the issuing counterparty. The FTSE only capital-at-risk autocalls issued to date utilised eighteen counterparty banks, nine of which were participating in the sector in 2021. The chart below highlights that the most prevalent counterparty was Investec Bank, issuing approximately one in five of all contracts. This will however no longer be the case following Investec’s announcement in February 2021 that it was withdrawing from the market. Participating Counterparties in FTSE linked capital-at-risk autocalls, issued 2003 - 2021 Investec Barclays Societe Generale HSBC BNP Paribas

Morgan Stanley Goldman Sachs Credit Suisse Natixis Santander & Abbey National Royal Bank of Scotland Others & not known Citigroup Lehman Brothers

0

50

150

100

350

250

300

400

200

Four FTSE 100 linked autocalls issued between April and August 2008 utilised Lehman Brothers as counterparty and as such, failed in October 2008 when the bank collapsed. Whilst these investments did not therefore, ever mature, the wind up of the Lehman’s’ estate saw investors recover between 76.53% and 97.48% of original capital, depending upon the product, albeit this was paid in instalments over the following 11 years.

7

FTSE 100 Autocall Maturity Analysis

The 1,250th FTSE only linked capital-at-risk autocall plan to mature did so in February 2022. Augere FTSE 100 Super Defensive Kick Out Plan Issue 3 successfully matured after three-and-a-half years, returning investors’ original capital in full in addition to a gain of 19.81% - or an annualised return of 5.29%. For context, the FTSE 100 Index fell by 1.7% over the same investment term. UK retail FTSE 100 linked, capital-at-risk, autocallable structured product maturities 18

16

14

12

10

8

6

Annualised Returns (%)

4

2

0

2003

2006

2009

2011

2014

2017

2020

As can be seen, there is a gap in product maturities coinciding with the coronavirus pandemic and resultant market correction. However, this is certainly a case of ‘Don’t Mind the Gap’. The nature of autocall plans means that missing an opportunity to mature early is far from a bad thing. The cumulating effect of the coupons means that the longer the market takes to recover, provided it does recover sufficiently to trigger a maturity on, or before the final maturity date, the greater the return. Eight of the 1,250 maturities returned no gain. These commenced prior to the financial crisis and the FTSE 100 Index did not recover prior to their final maturity dates but the capital protection barriers remained in-tact. These eight products had maximum durations of five, or six years and had this been seven, or eight years, as is more common today all but one would have matured positively, on or before the seventh anniversary.

Overview of the FTSE autocall maturity data

All 1,250

Last 1,000

Number maturing at a gain Number maturing at a loss Number returning capital only Mean annualised return Lowest annualised return

1,242

1,000

Nil*

Nil Nil

8

7.88% 0.00% 4.66% 16.2%

7.6%

4.66% 4.66%

Lowest annualised return (where a gain was achieved)

Highest annualised return

16%

Shortest term Longest term Average term

6 months

6 months

6 years 2 years

4 years 2 years

All but 8 (99.36%) of the first 1,250 maturing FTSE linked capital-at-risk autocall products successfully matured with a gain for investors – the remaining 0.64% (eight plans) returned investors’ original capital in full, but with no further gain. The 1,250 plans matured with an average annualised return of 7.88%, across an average term of two years. Worthy of note, no maturing FTSE only capital-at-risk autocall has failed to realise a gain since April 2013. All of the last 1,000 of these products to mature did so with a gain, achieving an average annualised return of 7.6% across an average investment term of two years. *As previously discussed, four FTSE 100 linked autocalls failed in 2008 and as such, never reached maturity as these utilised Lehman Brothers as counterparty.

8

About Lowes Financial Management & Structured Products

Lowes, established in 1971 are independent, chartered financial planners and investment managers with a broad variety of expertise across all aspects of wealth management. As independent financial advisers, we assess the whole investment space to ensure that our advice is individually tailored to our clients’ financial goals. In doing so, we consider alternative as well as familiar investments and retirement solutions. Our expertise in the structured product sector is widely acknowledged and respected. We have been evaluating all new entries to the retail market for more than twenty years, during which time we have played a significant role in helping to educate the wider adviser community about the sector, whilst helping to shape it for better investor outcomes, by championing good product design and governance and warning against some of the less desirable, historic sector additions. Over the last two decades we have published details of over 8,000 product reviews, whilst identifying which of these we ‘Preferred’ and as such, prepared to utilise in client portfolios. In more recent years, we have used our sector knowledge to help bring to the market new product shapes, such as the Mariana 10:10 Plan which influenced significant improvements to other new issues across the sector. We also manage the Lowes UK Defined Strategy Fund, an innovative UCITS fund of structured investment strategies, which draws upon our unrivalled experience and structured investment selection success. The Fund provides an easy way to invest across multiple structured investment strategies, linked predominantly to the FTSE 100, with no more than 10% credit exposure to any one bank. It is available on many major investment platforms. To access further information visit www.UKDSF.com.

Call: 0191 281 8811 Email: enquiry@Lowes.co.uk Visit: www.Lowes.co.uk Say hello...

Address:

Lowes Financial Management, Fernwood House, Clayton Road, Newcastle upon Tyne, NE2 1TL

9

Lowes Financial Management Ltd is authorised and regulated by the Financial Conduct Authority