Investing in Guaranteed products [EU]

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Topic Author
Spgold
Posts: 11
Joined: Fri May 10, 2019 4:52 am

Investing in Guaranteed products [EU]

Post by Spgold »

Hi all,

For someone who is going to need the money in 6-8 years or thinks that things will go down south for the next 6-8 years but still wants to stay invested in a portfolio that included stock, bonds and commodities / gold, would something like the following make sense?


https://produkte.erstegroup.com/Retail/ ... _NOTATION=

https://www.solactive.com/wp-content/up ... dex-35.pdf


From what I understand

1. The capital is 100% guaranteed at maturity (unless the issuer goes bankrupt ... in this case ERTSE) and participation in profits at maturity is uncapped.

2. No transaction costs on my behalf for rebalancing during the holding period and no taxes for any inside transaction made from the fund.

3. An annual expense of 0,13%.

4. Funds in this product are 95% IE & 5% LU (the commodity one).

5. No dividend paid, so no income TAX during the holding period.

*** On the other hand it does not seem to be UCITS compliment so that there could be GAINS tax once it matures and profits have been generated.


Sounds to god to be true ?

Any pitfalls I’m missing ?


Looking forward to your thinking.
Thanks!
glorat
Posts: 678
Joined: Thu Apr 18, 2019 2:17 am

Re: Investing in Guaranteed products

Post by glorat »

Spgold wrote: Sat Sep 19, 2020 11:35 am Sounds to god to be true ?

Any pitfalls I’m missing ?
You listed all of the positives of the product but none of the downsides! Fortunately, it is all their in their KID document. Let's start with their first sentence

"You are about to purchase a product that is not simple and may be difficult to understand"

I agree with their assessment. Let's start with what you may have misunderstood.

The second PDF link you posted (https://www.solactive.com/wp-content/up ... dex-35.pdf) is about a blended index that consists of
25% Developed World Stocks
10% Emerging Markets Stocks
50% Global investment grade Bonds
10% Gold
5% Other Commodities

If you told me you were going to invest in such a profile, I'd say that's a fairly reasonable investment choice at a moderate risk profile. It's value could go up or down over the next 6-8 years but it is close enough to other popular profiles and can be implemented at low cost.

Except that's not what you're investing in at all. The product in question is the first link and you need to check the KID for this actual product, which is at https://erstebankdownloaddocumentservic ... 20%5Ben%5D
It is imperative you understand this document before buying this product. The main "catch" is explained by them thus:
Redemption at maturity will be the base rate plus the performance of the underlying ... Performance means the percentage change
in the closing price of the underlying compared to the strike price
And that strike price is... Strike Price: 102.23 Points

So my interpretation is that this product is equivalent to buying a long call option on the index with a Strike of 102.23. In other words, After 6-8 years, if the index has risen by 2.23% or less, you don't get any gains. And if the index has risen by more, you must deduct 2.23% off the total gains.

So how to evaluate this product? Is it good, bad or terrible?

The first thing to say about this guaranteed structured product is this: Every sale of this product is guaranteed to make profit for the seller at zero risk! Because of this, typically these products are hard sold to retail people (like yourself) and they may even employ the cost of sales people and sales credits, just because the margins on selling these things are so lucrative.

They can make this free profit because it is possible to implement this at a lower cost than the product is being sold for. At a guess, I assume the trick here is in that strike price... the market equivalent strike price is lower so by buying all the relevant underlyings+options (or, more likely, taking an approximation and delta hedging over its lifetime). So I can't say this product is "great".

But is this product terrible? Actually, surprisingly to me, maybe not. If you like this product, you implement something similar yourself by simply buying something like (sorry I don't have the maths nor market info the leverage numbers) 90% bonds and 10% call options on some All World index. Over 6 years, the interest from bonds should pay for the premiums of the call options, thus almost ensuring you don't lose your original capital - while still getting unlimited upside equity exposure. The point is that this investment profile, like the product proposed, could be classified very low risk, which is very attractive to retail investors, especially new ones. Of course, DIY here is too complicated, which is why if you want such a risk profile (capital guaranteed), the product is a reasonable option.

But what would I say the product is a "bad" idea? We are Bogleheads. We should understand that the cost of "capital preservation" is actually a really high price. The long term impact on returns is huge. I wish some backtesters in this forum would quantify this for us. Since you're in this forum, I'd instead consider a conservative 2-fund portfolio of 80% bonds and 20% stocks. Although this doesn't carry the capital preservation guarantee, the risks of losing money over a 10 year period are very low but I expect the upside to be much better.

In short, the two downsides the KID missed are
- A likely unfair strike price that guarantees profit for the seller
- Much lower expected returns and not much more safety vs a simple conservative 20/80 portfolio

My request to other posters in this forum: Please could someone back test a 20/80 portfolio vs a 80% bonds, 20% call options portfolio (or 90% bonds, 10% call options), in order to back up my last claim.
glorat
Posts: 678
Joined: Thu Apr 18, 2019 2:17 am

Re: Investing in Guaranteed products

Post by glorat »

And now for the interested theoreticians.

This product seems to be a modern variant of the "Guaranteed Equity Bond". Their main feature was the guarantee of capital preservation. In the past, they could even offer full returns from the market (i.e. a strike price of 100), either by having bonds that offered far above today's zero interest rate regime, or with tricks such as the seller keeping all dividends (ouch!) or capping gains (ouch!). So in fairness to the above, the investors is indeed benefiting from underlying dividends with unlimited upside so having a strike price is the only fair way to sell.

What is in common with all "Guaranteed Equity Bond" structured products is the guaranteed risk free profit for the seller, and continues to be the reason why I would avoid them. I do however enjoy reading and decoding the KIDs of these things to pick them apart. (And, ahem, I once in my life indirectly had a role in making them available to the world)

One useful reading is this: https://monevator.com/guaranteed-equity-bond/ - which describes a recommended way of doing a DIY equivalent with simplicity and low cost - alhough it doesn't work so well now that interest rates are so low. (Or in other terms, the risk free rate of interest these days is near zero, so you're not going to get much market return if you want to have no risk like guaranteed capital preservation)
Topic Author
Spgold
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Joined: Fri May 10, 2019 4:52 am

Re: Investing in Guaranteed products

Post by Spgold »

Thank you Glorat for the detailed analysis and explanation.

I just have a couple questions:

1. As far an alternative approach is concerned (p.e. 80 Bonds / 20 Stocks) isn’t it more risky as far as Capital Preservation is concerned when :

A) my time horizon cannot expand more than 6-8 years (compared to the 10 y you mention).

B) in today’s interest rate environment as well as with the effective duration most bond funds have, isn’t it a bit risky to hold 80% of them regarding the capital preservation point for the 6_8 y time horizon ?

C) isn’t it better to give up this 2.23% to the upside for the whole period Instead of keeping the amount in Cash ? I m not concern about Cash generating any returns, but rather that 100K per bank capital guarantee.


In order to make things simplier, my main target is to have the Capital as safe as possible without decreasing the total amount for the next 6-8 years and at the same time having the possibility for it to have any returns (if any).

*** BUT main goal is capital preservation for a purchase that will take place in 6-8 years from now in a predetermined price that has been agreed on today.

What you gents/ladies think ?
Thanks
Valuethinker
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Re: Investing in Guaranteed products

Post by Valuethinker »

My general experience of these is that they are poor to terrible value for the investor.

Banks make money by creating these opaque products and flogging them to unwary investors.

The loss of dividend income alone for 8 years is c32% of the value of the European index and more if dividends are increased.

I think it would be better to be 80% global bonds hedged into Euros and 20% global equities OR 80% bonds and the rest buying near the money short dated calls on the index.
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WoodSpinner
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Re: Investing in Guaranteed products

Post by WoodSpinner »

Spgold wrote: Sun Sep 20, 2020 2:48 am Thank you Glorat for the detailed analysis and explanation.

I just have a couple questions:

In order to make things simplier, my main target is to have the Capital as safe as possible without decreasing the total amount for the next 6-8 years and at the same time having the possibility for it to have any returns (if any).

*** BUT main goal is capital preservation for a purchase that will take place in 6-8 years from now in a predetermined price that has been agreed on today.

What you gents/ladies think ?
Thanks
Why wouldn’t you just by a Treasury STRIP for the amount you need with the appropriate duration.

This will inexpensively allow you to meet your main goal.

WoodSpinner
Topic Author
Spgold
Posts: 11
Joined: Fri May 10, 2019 4:52 am

Re: Investing in Guaranteed products

Post by Spgold »

WoodSpinner wrote: Sun Sep 20, 2020 11:02 am
Why wouldn’t you just by a Treasury STRIP for the amount you need with the appropriate duration.

This will inexpensively allow you to meet your main goal.

WoodSpinner
Was not aware of them. Just did a little research on what they are and seem to fit the purpose.

Where and how can one buy them ? Since there are backed by the US do they fall under the US $ 60.000 rule ?
Thanks
Topic Author
Spgold
Posts: 11
Joined: Fri May 10, 2019 4:52 am

Re: Investing in Guaranteed products

Post by Spgold »

Valuethinker wrote: Sun Sep 20, 2020 9:29 am
I think it would be better to be 80% global bonds hedged into Euros and 20% global equities OR 80% bonds and the rest buying near the money short dated calls on the index.
Thank you for the input.

Would the bonds be AGGH for example or Government bonds ?

Wouldn’t 80% bonds face the hazard of effective duration in case interest rates go up during the 6-8 year time horizon ?

Thanks.
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WoodSpinner
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Re: Investing in Guaranteed products

Post by WoodSpinner »

Spgold wrote: Sun Sep 20, 2020 12:43 pm
WoodSpinner wrote: Sun Sep 20, 2020 11:02 am
Why wouldn’t you just by a Treasury STRIP for the amount you need with the appropriate duration.

This will inexpensively allow you to meet your main goal.

WoodSpinner
Was not aware of them. Just did a little research on what they are and seem to fit the purpose.

Where and how can one buy them ? Since there are backed by the US do they fall under the US $ 60.000 rule ?
Thanks
I can buy through Fidelity pretty easily. Most brokerages will be able to trade treasury STRIPs.

Not sure what the US $60.000 rule is?

WoodSpinner
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Raymond
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Re: Investing in Guaranteed products

Post by Raymond »

OP, are you a citizen of the United States or of an EU country?
"Ritter, Tod und Teufel"
Topic Author
Spgold
Posts: 11
Joined: Fri May 10, 2019 4:52 am

Re: Investing in Guaranteed products

Post by Spgold »

Raymond wrote: Sun Sep 20, 2020 7:10 pm OP, are you a citizen of the United States or of an EU country?

Yes, sorry about that. EU citizen.

Not sure I can have access to STRIPs ...
Valuethinker
Posts: 41144
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Re: Investing in Guaranteed products

Post by Valuethinker »

Spgold wrote: Sun Sep 20, 2020 1:52 pm
Valuethinker wrote: Sun Sep 20, 2020 9:29 am
I think it would be better to be 80% global bonds hedged into Euros and 20% global equities OR 80% bonds and the rest buying near the money short dated calls on the index.
Thank you for the input.

Would the bonds be AGGH for example or Government bonds ?

Wouldn’t 80% bonds face the hazard of effective duration in case interest rates go up during the 6-8 year time horizon ?

Thanks.
In practice whether you use global govt bonds or Barclays aggregate credit should not matter much. Former has less volatility.

You are right re interest rate risk. Solution is either to hold bank deposits OR to keep adding a short term bond fund to the mix, raising the percentage to 100% say by year 6. That would still leave a small amount of volatility.

A zero coupon govt bond, risk free, would also work. For the Eurozone is there one for Germany?
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LadyGeek
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Re: Investing in Guaranteed products

Post by LadyGeek »

Spgold wrote: Mon Sep 21, 2020 12:42 am
Raymond wrote: Sun Sep 20, 2020 7:10 pm OP, are you a citizen of the United States or of an EU country?

Yes, sorry about that. EU citizen.

Not sure I can have access to STRIPs ...
I have added EU to the thread title.

Spgold - You can change the thread's title further by editing the Subject: line in Post #1.

(Thanks to the member who reported the post to request the clarification.)
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
Topic Author
Spgold
Posts: 11
Joined: Fri May 10, 2019 4:52 am

Re: Investing in Guaranteed products

Post by Spgold »

LadyGeek wrote: Tue Sep 22, 2020 6:46 am
Spgold wrote: Mon Sep 21, 2020 12:42 am
Raymond wrote: Sun Sep 20, 2020 7:10 pm OP, are you a citizen of the United States or of an EU country?

Yes, sorry about that. EU citizen.

Not sure I can have access to STRIPs ...
I have added EU to the thread title.

Spgold - You can change the thread's title further by editing the Subject: line in Post #1.

(Thanks to the member who reported the post to request the clarification.)
Thank you for the suggestion, I thought that by posting it to the NON - US Investing was enough, but this way it will make things a lot clearer and easier for other members.

Title Seems OK now, thank you.
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