Lowes UK Defined Strategy Fund: Construction Of The Initial Portfolio
The Lowes UK Defined Strategy Fund (the “Fund”), launched in December 2018. Since inception the initial portfolio has been constructed, consisting of a mixture of auto-callable notes and ‘Over-The-Counter’ (“OTC”) contracts backed by gilts. Although the Fund can invest up to 20% of its assets in investments linked to overseas indices, all the contracts in the current portfolio (as of 05/11/2019) are linked to the FTSE 100 index.
The Fund contains a portfolio of auto-callable structured notes, each of which have different maturity parameters with defined outcomes, that vary as market conditions vary. For the purposes of this article each of these structured notes may be referred to as a ‘strategy’. As of (05/11/2019), there are a total of 18 different strategies within the portfolio, ranging from those that required the FTSE 100 Index to rise 5% or more from the Initial Index Level, to one that will still return a gain at maturity. For example, even if the FTSE 100 falls by as much as 25% from its beginning price level, this, combined with the staggering of the investments, means that the Fund contains strategies which will return a gain on their final potential maturity date at a range of different FTSE 100 values, from 7,553 at the highest, to 5,280 at the lowest, subject to the continuing solvency of the counterparty issuing the strategy. Further details upon each of these strategies can be viewed by anyone eligible to invest in the Fund at UKDSF.com/Portfolio
Lowes Investment Management Ltd, (the Investment Manager), have diversified the counterparty exposure in accordance with UCITS regulations, limiting counterparty credit exposure by spreading the auto-callable notes across nine separate investment grade banks, and all the OTC contracts are backed by a portfolio of short-dated gilts.
The below chart displays the credit exposure of the Fund, as of the 5th of November 2019.
As of the 5th of November 2019, the Fund has 6.2% in cash, and 50.1% in gilts and gilt backed contracts, meaning that the portfolio exposes less than half of the assets within the Fund to the potential default of banks. The returns offered by the strategies in return for assuming credit risk from banks tends to be higher than strategies utilising gilts and OTC contracts, due to the credit risk premium assumed by the investor, assuming other factors such as volatility, and interest rates remain equal.
The more obvious risk contained within the Fund is market risk. This is where an investor exposes their capital to the fluctuations in the movements of the underlying assets; namely the FTSE 100 Index for this Fund. There are several ways in which investors can assess market risk. In the case of the Lowes UK Defined Strategy Fund, we measure the sensitivity of change in the Fund’s value relative to the underlying index through a measure called Delta. A Delta of 1 would indicate that the Fund should move in line with the underlying, whilst a Delta of 0.5 would indicate that the Fund should rise or fall by 50% of the movement in the underlying. As of 5th of November 2019, the Fund’s weighted Delta is 0.4464. Given that the Fund diversifies across varying strike dates, maturity parameters, and strike levels, we would expect the Fund’s Delta to be less than that of the underlying assets in the medium-to-long term, assuming all but the most extreme market conditions.
The Investment Manager has chosen a variety of strategies with varying Deltas and levels of credit risk to manage the overall risk of the portfolio. By diversifying the credit risk of the portfolio, we reduce the potential for the Fund to lose value as a result of counterparty default. For information in relation to Fund risks please reference the Fund Supplement – access information can be found at the end of this article.
Here are a few examples:
Fund Autocall Strategy 4 – A strategy that requires growth in the underlying
A ten-year strategy that can mature from year one onwards providing the FTSE 100 Index is at or above 105% of the Initial Index Level. This strategy contains a capital protection barrier of 65% that will only be observed at the end of the ten-year term, providing the strategy does not mature early.
Potential Return: 16.50% for each year the strategy is held.
Credit Exposure: Morgan Stanley
Fund Autocall Strategy 8 – A strategy that requires the underlying to be at or above a reducing maturity trigger level
A seven-year strategy that can mature from year one onwards providing the FTSE 100 Index is at or above a reducing maturity trigger level, starting from 105% of the Initial Index Level in year one, reducing to 100% in year two, followed by a further 5% reduction for years three, four, five and six (95%), and a final 5% reduction in year seven (90%). This strategy contains a capital protection barrier of 60% that will only be observed at the end of the seven-year term, providing the strategy does not mature early.
Potential Return: 9.20% for each year the strategy is held.
Credit Exposure: Canadian Imperial Bank of Commerce
Fund Autocall Strategy 12 – A strategy that requires no growth in the underlying
An eight-year gilt collateralized strategy that can mature from year one onwards providing the FTSE 100 Index is at or above 100% of the Initial Index Level. This strategy contains a capital protection barrier of 60% that will only be observed at the end of the eight-year term, providing the strategy does not mature early.
Potential Return: 8.95% for each year the strategy is held.
Credit Exposure: UK Government Bonds
The portfolio will continue to evolve as new money comes in and existing strategies mature. Depending on pricing, market levels and outlook at that time new strategies may be added, or existing ones may be increased. Before being added to the Fund, all strategies are subject to rigorous back testing, whilst considering the current position of the portfolio and behaviour of the underlying asset (for example, the FTSE 100 Index). Strategies are not selected solely upon their own merits, but in the context of their contribution to the wider portfolio.
The source for all information in this article can be found at UKDSF.com/Portfolio or is otherwise sourced by Lowes Investment Management.
If you would like to know more about the Lowes UK Defined Strategy Fund, please visit the Fund website (UKDSF.com) or call Lowes Investment Management on 0191 281 88 11.
This article is for information purposes only and should not be construed as advice. We strongly suggest you seek independent financial advice prior to taking any course of action.
The value of this investment can fall as well as rise and investors may get back less than they originally invested. Past performance is not necessarily a guide to future performance.
The Fund is suitable for investors who are seeking capital growth over a medium to long term horizon but who are willing to tolerate medium to high risks due to the potentially volatile nature of the investments.
The Lowes UK Defined Strategy Fund is a sub-fund of the Skyline Umbrella Fund ICAV and is regulated by the Central Bank of Ireland. The KIID, Prospectus, and Supplement can be accessed by visiting UKDSF.com/Literature and are only available in English.
Lowes Investment Management Ltd, Fernwood House, Clayton Road, Newcastle upon Tyne, NE2 1TL. Authorised and regulated by the Financial Conduct Authority.