Warranting a new investment approach when a market lacks direction
Elizabeth Tian looks at what products investors are looking at to help protect against the uncertainty of a market’s direction.
Sometimes you need to look to the past in order to find a brighter future. It's a saccharine saying, I know, but it's one of the ways in which I can concentrate over the perpetual looped instrumental moan which rings in my head when I'm frequently told by financial advisers that their clients are reticent, anxious, by current directionless equity markets.
That cacophony from the past is no other than legendary British post-punk band, Joy Division. The music from New Dawn Fades begins with a sepulchral bass guitar heralding a rhythm section, ultimately freeing the song to its ascent.
Tenuous maybe, but its hallmarks to a directionless market are real. Tellingly, I find analogy in the lyrics: "Different colours, different shades, Over each mistakes were made. I took the blame. Directionless so plain to see".
Stay with me here, at a minimum, if you share that same sense of uncertainty regarding directionless markets or, at best, identify as Generation X or Baby Boomer, who grew up at a time of this innovative musical genre and yearn for a comfortable financial future.
This year alone we've seen the market falling back to 4,700 and advisers lament that with up to 40 per cent of their client's individual funds in cash at historically low yields they are struggling to find alternative risk weighted returns, including income for their hungry self-managed superannuation funds (SMSFs).
Traditionally, there's a plethora of investment choices in a bull market that offer equity exposure but in a sideways market there's a dearth available for the retail or SMSF investor.
Looking closer to the home of those aforementioned moody lyricists, investors in European markets have, in the recent past, actively sought ways to invest in equity markets with some degree of protection from volatility.
To combat this, offshore investors have turned to simple unleveraged investment style certificate products which now total a 97 per cent market volume (in warrants and certificate style structures) compared with leveraged products.
Indeed, analysis shows that in Europe alone there are now approximately 1.9 million (issued securities) such unleveraged certificates in market with an equity value of about €2.2 billion ($3.5 billion). Plainly that's an endorsed approach to protecting against the uncertainty of a market's direction.
In a first for the Australian market, investors can seek similar protection through bonus certificates, unleveraged warrants, over Australian listed securities.
Notably, with no loan component, they include some protection if they trade above a predetermined barrier level for the entirety of their term.
Bonus certificates are most effective when markets trade in a range, provided that range does not breach the underlying shares' barrier level. Bonus certificates include a bonus level that is higher than the price at issue and a barrier level that is below the price at issue.
At maturity, the investor receives the bonus price provided that the barrier is not breached during the term of the investment. If the bonus certificate trades above the bonus level or below the barrier level, the investor participates in the full upside or downside of the value of the underlying asset.
Simply put, these investment products are an alternative to a direct investment in securities for those investors who are looking for a degree of protection. They can yield positive returns whether the price of the relevant underlying instrument is rising, stagnating or falling slightly.
An investor, for example, can invest in a Telstra bonus certificate (TLSBOE) currently at $4.94, with downside protection if Telstra does not fall to $4.10 (pre-determined barrier level) in the next 14 months.
Instead of receiving dividends and franking credits assigned to the underlying shares an investor receives a Bonus with Telstra Bonus Certificates if the barrier is not breached, i.e. Telstra does not fall to $4.10.
Investors through bonus certificates can hold one pre-dominant view; if a stock, in this case Telstra, does not fall to $4.10 or lower during the term they will receive $5.75 (or higher whichever ends up been greater).
Similarly, with other shares if they hold the investment position that the Commonwealth Bank (CBA), currently at $69.50, will not fall to $58.50 or lower they will receive $80.75 or higher at expiry in November 2017 whichever is greater by holding the CBABOF bonus certificate.
Investors can purchase bonus certificates through their broker like other listed securities. The bonus certificates will sit alongside an investor's share portfolio on the holder identification number through the investor's account.
As bonus certificates are listed just like the underlying shares they may be traded at any time. Currently the indicative cost for a bonus certificate is one per cent for 12 months, or part thereof if held for a shorter period to sell out early in order to capitalize the profits.
And what of those moody lyricists?
Well the penultimate verse in New Dawn Fades surely provides the lament of many an investor seeking guidance in a directionless market: "Hoping for something more…". If only they had unleveraged warrants to guide them.
Elizabeth Tian is the global markets director at Citi.
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