Keeping Our Definition

During the Christmas and New Year celebrations definition was perhaps the last thing on your mind. With all the additional goodies on offer, such as mince pies and a chocolate or two, waist bands have had the potential to expand a little, I know mine certainly has. As we enter 2021 it is perhaps a goal to bring back a little definition. Within the MI Diversified Strategy Fund we are intent on holding onto ours by continuing to allocate to structured notes.

At the end of 2020 the Fund had an allocation of 9.35% to this asset class and following our latest assessment of the individual holdings we continue to see the potential for latent value. Whilst predicting where the FTSE 100 will be in 1, 3 5 or 10 years’ time is nigh on impossible, the defined return profile provided by structured notes means that should an underlying index level be at or above a payout level on a pre-determined date, we can calculate what the potential return from that investment would be.

Exposure in the Fund is diversified across 7 different banks and 12 different individual holdings, helping to provide diversification in terms of credit risk, observation dates and index levels required for a note to mature, or kick out. There is also diversification across strategy types, including some notes where the observation level is the same throughout the term, to those with a defensive feature, where the observation level decreases over time.

So what is this latent value we refer too? To demonstrate this let us look at some of the underlying holdings. Our first example is an autocall which originally struck in December 2018. With the potential to run for a 9.25 year term, it offered on its strike date a coupon of 16.6% for the first 1.25 years, maturing if the FTSE 100 was at or above 6,721.17 on the observation date. If the index were below it would run for a further 12 months, paying an additional 16.6% for that period.

It is this second observation date that we are now approaching in March 2021. Whilst the price of the note, at 119.08 is already reflecting the potential for it to mature this is still some way behind the payout price of 133.20. Therefore, if the FTSE 100 were to rise 4.03% from its year end level of 6,460.52 by the observation date, there is still the potential for a return of 11.86% from the end of year price. Even if this note were to run its full term to March 2028 the additional coupons payable would mean that there is still the potential for a 109.44% return from here, annualised 10.77%.

Our second example is again an autocall, this time which initially struck in January 2019. Offering a coupon of 9.83% for each 12 month period, it has again passed its first observation in September 2020. Its next observation date is in August this year where, if the FTSE 100 is at, or above 6,833.93, 5.78% above its end of 2020 level, it will mature at125.39. The potential for this is again reflected in the price at the 31 December of 110.78. The potential gain remaining of 13.19% however from its end of year price is one which we believe is attractive relative to the 5.78% rise in the FTSE 100 needed. Even if it were to not mature at this next observation point it still has the potential to mature on a further 4 observation dates. Whilst the FTSE 100 level required in August 2022 remains the same, following that the structure then benefits from a defensive feature whereby the observation index level required falls by 5% each year.

When it comes to equities, or equity like investments it is nigh on impossible to quantify what the potential return will be. Whilst valuation metrics can be used to calculate a target share price for example this does not provide a clearly defined return profile as one person’s target price can be very different to that calculated by the next. Furthermore, the share price needs to attain that target price. Whilst the return profile from structured notes can change due to mark to market price changes between observation dates, the return profile can be recalculated along with the movement in the underlying index required for that to be achieved. It is this which we constantly stay abreast of. Whilst you of course remain reliant on the movement of the underlying index or indices, a little bit of definition in your portfolio can indeed add value.

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 to achieve long term capital growth.

The tax treatment of investments depends on the individual circumstances of each client and may be subject to change in the future. The above is in relation to a UK domiciled investor only and would be different for those domiciled outside the UK. We strongly suggest you seek independent tax advice prior to taking any course of action.

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