16/09/2021

Josh Mayne, Lowes Financial Management

 Last week IDAD released two structured deposits into the retail space – IDAD The Callable Deposit Plan Issue 12 November 2021, and IDAD The Enhanced Callable Deposit Plan Issue 2 November 2021.  The former protects capital in full and offers clients 60% participation, uncapped, in the FTSE 100 Index at maturity, and the latter offers 150% participation, uncapped – but there’s a price to pay for this.

 With both plans, the Deposit Taker (Goldman Sachs International) has the right to terminate the deposit on any quarterly observation date from the second anniversary onwards when they will compensate with an interest payment of 5% or 7.5% respectively per it has been in force. It is worth noting that we believe an early termination in this manner is highly unlikely, and it is the end participation that investors should base their investment decision on.

 Structured deposits effectively take the interest that would otherwise be earned on a fixed term deposit over the term and swap it for equity market exposure. As an example, a structured deposit we ‘preferred’ five years ago offered a 34% gain if the FTSE 100 was higher at the end of six years. This commenced in 2016 when Bank of England Base Rate stood at half a percent and so the deposit involved giving up not a lot of potential interest that would have been received from a standard or fixed term deposit account and potentially returning an equivalent compound annual rate of almost 5%.  Worth the risk we thought.  As it happens, with ten months to go, the FTSE 100 stands at more than 1000 points higher than where it needs to be to trigger the 34% interest payment.

 As we all know, interest rates have come down further thanks, in part, to the pandemic and now money on deposit can expect to earn very little, as opposed to not a lot. So how much equity market exposure does very little interest buy you nowadays? The answer is ‘not a lot’.  Sixty percent over seven years, in the case of Issue 12 of IDAD’s latest offer.  Whist the terms aren’t quite identical, for this structured deposit to provide the same return at the end of its term, as our example above, maturing next year the FTSE 100 would need to be more than 56% higher. In fact, it would need to be more than 15% higher just to beat the guaranteed return that could be achieved from fixed term deposits. So, what’s the alternative?

 Well obviously, putting capital at risk enhances potential returns and if you’re optimistic enough to expect a 56% rise in the stock market over the next six years then you’re no doubt taking on the risk. But in the deposit space which offers the surety of capital choices are thin.

 IDAD’s latest innovation, The Enhanced Callable Deposit Plan, has sought to bridge the gap but raised more than a few eyebrows in our office. This plan has a nuance whereby the clients are guaranteed to lose 5% of their initial capital if the FTSE doesn’t rise – a 5% ‘Initial Payment’ is taken from the initial investment, and so 95% (the net deposit amount) is actually deposited.

 FVC’s analysis of the product indicates that 32.91% of back tested simulations resulted in capital loss and under their simulated probability assessment this percentage rises to 45.59% (FCV).   

 The ‘enhanced’ deposit is guaranteed to lose 5% of investor’s capital in flat or falling markets, however the basic principle of a structured deposit has always been that no matter what, you are assured the full return of your capital if left until maturity. Even if the bank defaults, deposit capital is FSCS protected up to £85k. So, a deposit that could return less than invested capital, and ultimately puts capital at risk, doesn’t sit well with us. 

 That said, the literature does not seek to hide the 5% cost and implications of it and we recognise that with interest rates were they are, there is very little to play with and IDAD have simply tried to innovate to meet demand in very difficult market circumstances.  We hope that the ultimate outcome is a positive one – outperforming fixed term deposits.