ARF Investment – Challenges
In our first article we looked at some of the broader ARF investment challenges facing ARF & Pension investors.
In Article 2, we looked at some specifics relating to traditional Deposit Funds, Bond Funds, Property Funds, Equity Funds & Commodities / Precious Metal Funds.
Last week in Article 3, we explored the world of Absolute Return Funds, Multi Asset Funds, and Capital Secure Funds.
In our final article I promised we would look into the sometimes-confusing world of ‘Soft Capital Protected’ Funds.
Soft Capital Protected Funds
Soft Capital Protected Funds are also known as ‘Auto-Callable Bonds’ or ‘Kick – Out Bonds’. They are becoming increasingly prevalent in the Irish Market as an Arf Investment, especially over the past 18 months. At their core they seek to offer equity market like returns with some degree of capital protection. They should be seen as a means to gain access to equity markets with some degree of capital protection built into the product structure. They are not an alternative to deposits. They can be hard to understand, but once understood most of the soft capital protection options available on the Irish market follow the same principle. An example of how they work is as follows:
John has €50,000 to invest. He has identified a ‘Kick Out Bond’ with the following headline terms:
Underlying Fund: The S&P 500 US Index (500 Largest Companies on the US Stock Market)
Investment Term: Maximum 3 Years but possibly as short as 1 Year.
Potential Positive Investment Return: anywhere from 8% to 24%
Capital Security on initial investment amount: Conditional Soft Capital Protection
Underlying Investment: The underlying fund is the S&P 500 US Index.
What does this mean and how does it work?
The operation of the investment would be as follows:
Year 1
The Kick out Bond Tracks the value of the S&P 500 US Index. If, after 1 year the value of the S&P 500 Index is at or above 100% of the starting value, then the investment bond will cease and the original investment amount of €50K plus a fixed 8% return is paid out to investors.
If however, after 1 year, the S&P 500 Index is not valued at or above 100% of the starting level then the investment continues for another 12 months.
Year 2
If, after 2 years, the value of the S&P 500 Index is at or above 100% of the starting value (from Year 1) then the investment bond will cease and the original investment amount of €50K plus a fixed 16% (2 x 8%) return is paid out to investors.
If however, after 2 years, the S&P 500 US Index is not valued at or above 100% of the starting level (from Year 1) then the investment continues for another 12 months.
Year 3
If, after 3 years, the value of the S&P 500 Index is at or above 100% of the starting value in (from Year 1) then the investment bond will cease and the original investment amount of €50K plus 24% return is paid out to investors.
If however, after 3 years, the value of the S&P 500 Index is not priced at or above 100% of the starting value (from Year 1) the investor will not get any investment growth at all. They will only receive a return of their initial investment value of €50K and this return of initial capital is also dependent on the following provision (the ‘Soft Capital Protection’):
Soft Capital Protection Provision – Initial capital invested is applicable only where the S&P 500 Index has not fallen more than 40% of is starting price (from Year 1).
How does this soft capital protection work in practice?
Let’s look at the following possible outcomes where the value of the S&P 500 Index has fallen:
- The S&P 500 Index has fallen by 10%, that’s fine John gets his €50,000 back as the terms of the soft capital protection allow for a 40% drop.
- The S&P 500 Index has fallen by 30%, that’s still fine and John gets his €50,000 back as the terms of the soft capital protection allow for a 40% drop.
- The S&P 500 Index has fallen by 60%, John suffers a corresponding % loss on his investment as the soft capital protection barrier of 40% has been breached.
What does all this tell us about such Soft Capital Protection Investment options? Are they a good idea or not?
I think they can be summed up as follows:
- They offer the potential for very attractive investment returns similar to equities
- They allow for significant falls in the value of the investment before investors are impacted
- If they do fall heavily, for example by more than 40% based on the above example, investors will suffer heavy losses.
- They can form part of an investment portfolio but should only ever be a used as complementary fund in a larger more conservative investment strategy.
Thank you for reading and please feel free to contact us with your ARF Investment related questions.
We will also soon provide our Investment EBook for download on ARFIRELAND.ie for ARF Investors.
Michael Coburn BBS, QFA, FLIA, LCOI, RPA, SIA contact 053 9170507 email mcoburn@arfireland.ie
