Lowes Magazine Issue 116

INVESTMENT

BEING AT THE FOREFRONT OF THE UK STRUCTURED product sector not only means Lowes can bring our clients exceptional investments not available to the wider market, it also means we consult with the providers over sector development, with a view to further improve what has already evolved to be an exceptional investment area. We have consulted, at length over the latest sector evolution, the introduction of the FTSE Custom 100 Synthetic 3.5% Fixed Dividend Index (FTSE CSDI), something that we expect to become widely utilised as the underlying for many structured products going forward, and for good reason. In the UK retail structured products sector the FTSE 100 Index has been the most commonly utilised underlying, accounting for 67% of issued plans in the previous decade (2010 – 2019). The index is comprised of the 100 largest companies listed on the London Stock Exchange, weighted by their size and represents approximately 81% of the value of the UK’s stock market. Linking the performance of structured products to the performance of the FTSE 100 Index allows investors exposure to the UK equity market, via its most widely quoted benchmark. The FTSE 100 Index is however, a ‘price return’ index, meaning that it only considers price movements of shares that it consists of – it does not reflect the dividends paid out by these companies. The counterparty to a FTSE 100 Index linked structured product will however, base their terms on, amongst other things, the anticipated dividend yield that the shares in the Index are expected to produce over the holding period. This requires a degree of forecasting and it is not unreasonable to expect the bank to err on the side of caution. As a result of the Covid-19 pandemic, indications are that more recent dividend estimates, even after accounting for a margin of error have proved to be a little on the high side. The market weighted dividend yield from the shares in the FTSE 100 in 2019 was 4.35% and the Sector evolution: introducing the FTSE CSDI

latest forecast yield for 2020 as a full year is now 3.5%, which, coincidentally, is in line with the twenty-year average. This recent decrease, coupled with a higher than normal degree of uncertainty, makes forecasting more difficult, which means that the banks will build in a higher than usual margin for error. This has therefore played a significant role in the returns being offered on FTSE 100 Index linked structures being substantially lower than they have been. The FTSE CSDI was created by FTSE Russell, the same calculation agent that publishes the FTSE 100 Index, to provide a solution. It aims to closely replicate the performance of the same 100 companies but after including the dividends – the equivalent to the FTSE 100 ‘total return’ index, from which, a constant annual dividend of 3.5% is deducted. The FTSE CSDI index may therefore be expected to perform in a similar way to the FTSE 100 Index although, it will slightly underperform if the total dividend yield transpires to be less than 3.5%. The correlation of FTSE CDSI to the FTSE 100 over a 10-year simulated back-test is 99.86%. By removing the uncertainty of relying on future dividends, the issuing banks may face lower costs and risks. The risk, or even the expectation that dividends will be lower than 3.5% and vice- versa is, in turn, accepted by the structured product investor but the acceptance of this, together with the cost saving arising from the issuer not having to make assumptions on the dividends, ultimately leads to greater potential returns for the investor. The net result is that even if the performance of the FTSE CSDI slightly lags that of the FTSE 100, we believe that this should be adequately compensated for in the comparatively higher potential returns offered to structured product investors. The FTSE CSDI will be the underlying for Mariana 10:10 Plans going forward and we expect to see it utilised in many other new issues before long.

Whilst the FTSE 100 Index will serve as a broad proxy for the performance of the FTSE CSDI the actual index levels are published on FTSERussell.com and we will also keep track of the index levels on our own SP-Perspective.com.

FTSE CSDI: Historical performance vs. 100 Price Return Index (20 years)

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FTSE CSDI Rebased FTSE 100 Rebased

Source: Mariana Capital, 17 September 2020. The FTSE CSDI was launched on 1 July 2020, and the chart above therefore includes simulated historical performance up until this date.

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Index Level (both indices rebased to 100)

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Simulated past performance is not a guide to future performance.

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