Physicist crunches the numbers for investors
For a physicist turned banker, John McLaughlin cuts a fairly conventional figure. In his slim-cut black suit and crisp white shirt, his look is more FBI agent than quirky professor. His speech is laden with references to 'probabilities' and 'strategic objectives', while his approach is methodical but hurried.
That sense of someone who understands the small print in context of the big picture seems fitting for the London-based head of structured investments for Schroder Investment Management. No doubt his Oxford doctorate in mathematical physics helps the 41-year-old crunch the numbers on the call options, but it also lends an edge in grasping the theory behind the ever more complicated financial products investment houses are introducing to the market.
Take for example Schroder's new Accumulator Guaranteed Fund, the first in a range of new guaranteed products engineered for racier returns with variable maturities. The fund pays an automatic 10 per cent coupon in the first year and then a 1 per cent minimum payout each year until maturity. In this way, it enables investors to draw an income during the lifespan of the investment.
Technically the product takes up to 10 years to mature, but if the underlying equity component performs well after two years, the fund will automatically mature and pay out a 20 per cent return. Basically, it is designed to return capital the moment the underlying equity basket produces an overall 20 per cent return. If the equity basket, comprised of 20 international blue chips, never musters the desired return, the fund will pay back the original investment plus 19 per cent after 10 years.
Mr McLaughlin says it is likely the fund will trigger an early maturity, probably within a three- to five-year time span.Theoretically it is possible for the fund to pay out within two years.
'This product is very much geared towards conservative savers who want a one-off investment where they are taking a tactical view on the markets,' he says. 'Compared with a standard guaranteed product, it has a more certain return, but a less certain time horizon.'
Mr McLaughlin says the accumulator fund is positioned for investors looking to meet specific targeted returns, but also appeals to those seeking higher upside potential than in a traditional balanced fund of bonds and shares. A good example, he says, is a parent trying to save for a child's college education. You need to make a certain guaranteed return, but a potential bonanza would also be welcome.
To meet their financial obligations, most five-year guaranteed funds allocate about 80 per cent of assets to bonds and 20 per cent to equity call options.
These enable a capital guarantee and enhanced upside in the event of a strong rally in global equity markets. On the downside, the fund will lag the returns generated by a balanced portfolio over time if the equity markets fall into a prolonged slump.
He says a basket of guaranteed funds can be used as a low-cost way to manage an entire portfolio. Why pay a financial adviser, he says, when a basket of capital-protected funds can provide reasonable upside to global equity markets with little volatility?
Examined closely, most guaranteed funds let you sleep at night simply because they are mainly invested in low-risk bonds.
However, there is still a chance for reasonable upside, owing to the 20 per cent of capital invested in call options.
These sophisticated instruments make use of leverage to simulate equity exposure of 50 to 60 per cent, Mr McLaughlin says.
'There is a good strategic argument,' he says. 'If you have a portfolio of different capital-protected funds, with different underlying themes, then it becomes a credible alternative to a conventional investment portfolio.'
Investors should take note, however, sometimes the upside from guaranteed funds can be hard to find.
An initial tranche of three-year guaranteed funds, launched in Hong Kong by Schroders in 2001, matured last week. The equity portion provided no additional returns, owing to sour global equity markets for the 36-month term.
