Would you swap the chance to make large capital gains for a more dependable payout in the not-too-distant future? If so, how's this for a deal?
Société Générale's Synthetic zero or SocGen SG22 costs about £978. Each certificate promises to pay out £1,543 on 31 October 2012 – which is about 4.75 years away. This represents a defined compound annual return of 9.93 per cent over that period.
A 'defined return' means just that: your maximum return is pre-determined. But while you won't get any more than 9.93 per cent a year, you may possibly end up with less. That's because the certificate is structured in such a way that there are certain investment hurdles to overcome.
In this case, the hurdles aren't that demanding. You'll receive your defined return so long as the DJ Eurostoxx 50 – an index of very large European shares – isn't below 2402 on on 31 October 2012. The index is currently trading at 3707. There's obviously a small chance that this could happen. Multi-year bear markets are very possible, as the 2000-03 period reminded us so painfully. Realistically, though, the likelihood of the index ending up 35 per cent lower in five years' time is fairly low.
This particular instrument is just one example of the many defined returns products now available. Some investors may view this type of offer with suspicion. It bears similarity to the split-capital investment trust sector that sold zeros (zero dividend preference shares). In the case of zeros, the trade-off between the return and risk was simply too skewed towards the latter. Equally, many precipice bonds (structured products sold on the high street through independent financial advisers) offered defined returns in the future. Once again, though, the returns came at too great a cost in terms of the investment hurdles.
These scandals nearly spelt the demise of the humble defined returns fund, but they've just about managed to survive. There are a number of surviving split-capital zero funds still available as investment trusts, and the defined return is usually in the 6-8 per cent a year range. A list of available products can be found at www.splitsonline.co.uk and tend to be provided by the likes of Jupiter or JP Morgan.
Kick-out funds
The structured product providers have been much more active, selling rather more complicated products such as 'kick-out' funds that give you a short-term payout as long as a chosen underlying index hits its investment hurdle. Barclays Stockbrokers, for example, has just launched an investment note called the FTSE 100 Accelerated Return Investment Note. This five-year listed note will pay out 75p on every £1 invested as long as the FTSE 100 is still above the starting level – likely to be around 5800. The 'defined return' equates to an annual compound return of just over 11 per cent. While that's higher than the SocGen product, the investment hurdle is a little more demanding in that it requires the main UK index not to lose any value in the next five years.
If the FTSE 100 falls below that initial level, your defined return is in jeopardy and if it falls back by more than 40 per cent, your capital is at risk. Although, superficially, the Barclays' product is more alluring in terms of the headline rate, it doesn't quite match the risk/return profile of the SocGen Synthetic Zero.
