Structured funds that guarantee investors’ capital tend to be very popular after a market crash. Typically investors that get caught up in the market hype have full exposure to the equity markets and therefore suffer heavy losses when the markets fall.

Investors then tend to flee to funds that guarantee what little capital they have left. However guarantees always come at a cost as they limit the upside of your investment return by paying out a smaller percentage of the total returns. In most cases you forfeit dividends from the underlying shares.

After a major market correction, markets tend to recover strongly and investors in guaranteed products lose out on the recovery.

Guaranteed products are also not the correct vehicle for long term investing. If you have a time horizon of more than five years the likelihood is that the markets will deliver a positive return, yet you have forfeited some of that return, usually in the form of dividends. For example if you have a share with a dividend yield of 3%, over a five year period that would equate to a 16% return – so effectively the product has cost you 16% which is very expensive.

However there is a time and place for guaranteed funds as long as you fully understand the product, its costs and what you aim to achieve from the investment.

We are currently in a situation where South African equities are relatively expensive and fund managers recommend that we invest offshore. However globally the world is in a state of flux as Europe struggles to deal with excessive debt and the entire Euro zone threatens to collapse.

An investor wanting offshore exposure with no risk would have to invest in cash which provide returns of less than one percent. Investors therefore need to take some risk on investing in equities to see any reasonable growth.

It is with this in mind that Investec has launched its S&P500 Growth ESP which is a structured product that guarantees your capital in rands while providing offshore exposure.

The S&P500 Growth ESP is a 3.5 year product linked to the performance of the S&P500 index. At the end of the period your initial capital is guaranteed in rands, so you get your money back if the market has fallen. If there is growth you receive your initial capital plus 110% exposure to the increase in the level of the index.

For example if you invest R100 000 and the Index returned 27% over the period, you would receive 29.7% (as you receive an additional 10% on the Index return) which is then converted back into rands providing you with R29 700 (assuming the same exchange rate) plus your initial capital of R100 000 so you would receive a final payment of R129 700.

The downside is that your original capital investment does not benefit from any rand weakness. If the rand has weakened against the dollar your initial capital investment of R100 000 remains the same. It is only the growth on the investment that would benefit from exchange rate movements. You also sacrifice dividend income which is currently 2.12% for the S&P 500.

The product has fees of 2.25% and a 0.75% annual fee although these are built into the costs of the product so will not be reflected in your final return.

An investor wanting similar offshore exposure without a guaranteed structure could invest in Deutche Bank’s MSCI USA Index fund which is one of the db x-tracker range of exchange traded funds listed on the JSE. This has no guarantees but gives you dollar exposure to the US index.  After fees of around 1% the investor would receive net dividends of 1% per annum and all your capital would be exposed to movements in the exchange rate.

Comparing a structured product to the MSCI USA Index:

The investor invests R100 000 at an exchange rate of R8/$. After the three year period the index has risen by 27% and the rand has weakened to R10/$:

Ultimately you are paying for the peace of mind through a sacrifice in return both from dividends and a potentially weaker exchange rate so you need to weigh up the pro’s and con’s and make an informed decision.

This may be the right investment for you if:

• You are looking for a Rand capital protected investment
• You are looking for an investment where the upside is linked to the performance of the S&P500 index
• You do not need immediate access to your money for the term of the product
• You have a minimum of R50 000 to invest
• You are looking for a USD based investment with Capital protection in Rands
• You do not want to pay asset swap fees or utilise your annual foreign allowance

This investment may not be right for you if:

• You want to receive regular dividends and income
• You cannot commit to the full term of the product
• You want a known fixed return on your investment
• You do not want to take USD/ZAR exchange rate risk on the upside growth potential
• You want pure offshore exposure on your entire investment. (Only the potential upside return is in USD)

This article first appeared in City Press

This article first appeared in City Press