Evaluating Structured Products
At the 2007 Alpha Spring School earlier this month, we found that SMSF advisers and investors rate capital protected investments as one of their "Top 3" portfolio construction needs. See our easy to follow guide on how to navigate the world of capital protected products.
Investment markets are never easy to navigate, even though in hindsight we can often see clear trends and patterns of risk and return. As an SMSF and HNW professional adviser, you know that your clients value your counsel and assistance in building their investment portfolios. It is usual for these clients to be relatively risk averse (and we spent some time during the Spring School understanding what motivates the investment decisions of SMSF and HNW clients): thus, neither they nor you are happy to lose money, even in the prospect of chasing superior returns.
At the heart of modern portfolio construction for SMSF and HNW clients is the need to build durability and resilience into the investment portfolio, whilst at the same time ensuring that suitable innovative investments and strategies are embraced. This requires close attention to the two "Golden Rules" of investment and portfolio design:
- assets must be of "investable quality", ie. they must have some intrinsic value and rationale for their choice; and
- the vehicle or structure through which you make that investment must be sympathetic to the value drivers and risk of the investment.
For example, consider a geared investment into an exotic and unusual asset, such as (hypothetically) the currency of an emerging market nation. Ask yourself other than the speculative possibilities of this investment, would I have an intrinsic need or want to buy this asset? In this case, the answer is that you would not have such an intrinsic need or want: the emerging market currency would not normally give you exposure to a significant or consistently valuable economic or market return.
In comparison, we choose to buy shares in quality companies in developed nations because they do give us exposure to the economic return generated by well managed business activity in that market.
While it is possible to conceive of investment opportunities that sit all the way along the spectrum between "investable" and "non-investable" quality, it is also possible to develop a relatively clear 'brightline' test between acceptable and unacceptable assets: common sense and learned wisdom play a role in making these choices, as well as hard investment logic.
The choice of investment vehicle is also vital for our purposes. As an eminent ex Deputy Governor of the RBA has said: "You can’t teach a pig to sing opera". What Henry Thornton means is simple: there is no amount of investment structuring which can turn a "non-investable" asset into something that is investable. For example, wrapping a capital guarantee around a "non-investable" asset will normally mean that you do get back your money at the end of the investment term: but you aren’t likely to enjoy any growth or income during the life of the investment (meaning that in real terms you have lost money).
And it has to be said that using a unitised, actively managed Australian share fund, which is benchmark aware, will also produce inferior returns in a volatile market: a combination of lost crystallisation through portfolio churning, as well as through the tax inefficiency which high levels of turnover generate in the context of a unitised structure.
The core theme of the 2007 Alpha Spring School was to look at the "investability" of key assets over the near to medium term future, and then to evaluate the merits and risks of the key structured products that you are being shown by Australian and global investment banks. Like you, we are looking forward to remaining at the "cutting edge" of financial planning in 2008 and beyond. Building investment portfolio durability and resilience will be an important part of doing so.
On behalf of the Alpha Structured Investments team – if you haven’t already done so, please contact us so that we can spend some time with you exploring how Alpha products can add to the durability and power of your SMSF portfolio construction.
Phone: 1300 769 694
Email: alpha@alpha-invest.com.au
Tony Rumble, PhD.
