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Forward Thinking Magazine : April 2011
39 capital protection Written by Gayle Bryant, Journalist Many investors are venturing back into the sharemarket and asking about protected products, showing that consumer demand exists. Product solutions that increase the growth exposure of a portfolio while also protecting its assets can only be a good thing. But while investors are asking for products that protect their capital, they want more transparency and flexibility than these products offered before the GFC. There are a number of reasons why investors would choose to buy capital protection. For many, it is about peace of mind over time. “It is growth exposure versus asset protection,” Macquarie Wrap Head of Product Doug Chang says. “In many cases, if capital protection wasn’t offered, investors might be too nervous to make any type of investment apart from cash.” Macquarie Product Developer Luis Sarmiento says one of the issues with investing back into cash and out of the sharemarket is that you may be locking in any losses from the GFC and this limits the long- term returns that could be achieved. “Capital protection can offer a risk controlled opportunity to re-enter the market while it remains volatile,” he says. Advisers do need to determine whether capital protection is right for their clients. If the aim is only to protect capital, then an investor may be better off putting their money in a term deposit. But generally, investors want to enhance their growth and this is where capital protection can assist. How much of an investor’s portfolio should be protected depends to a large degree on the size of the portfolio and how much the investor can afford to lose. “If you can afford to lose 10 per cent of your portfolio, then perhaps you need protection for the other 90 per cent,” Sarmiento says. “The strategy needs to link into an investor’s risk profile. Protection is about taking greater control of your downside exposure to the market.” Sarmiento believes capital protected products are most suitable for investors who are conservative and want to increase their growth exposure. “Another good reason for protection is if you are borrowing to invest,” he says. “And it can also be used for investments that are speculative in nature, where you may want a feature like a stop-loss. Again, it links back to the growth exposure required.” “When assessing how much of a client’s portfolio to protect, advisers are more constrained with the current style of capital protected products for two reasons,” says Sarmiento. “Firstly, most products offer limited investment choice so it is difficult to protect a significant proportion of the client’s portfolio while achieving diversification at the same time. Secondly, most products are not integrated with Wrap platforms, which means advisers have to administer a client’s portfolio both on and off platform. This can drive up time, effort and therefore costs.” Types of protection There are a number of different types of capital protection offered by various providers. The three traditional ones are CPPI (constant proportion portfolio insurance), bond and call, and dynamic hedging. Macquarie is developing a new style, which will be known as client-tailored dynamic allocation. Each of the traditional styles has its own pros and cons, as highlighted during the sharemarket volatility of the past few years. CPPI is an automated investment process that moves investors out of equities and into cash as the market falls, and back into equities when it rises. CPPI can offer protection on a wide range of underlying investments and in rising markets it can offer full participation at a lower cost. One of the issues with the CPPI structure is that if it moves into 100 per cent cash, the investor can be locked into cash for the remainder of the term and unable to participate in any sharemarket rebounds. This is the style that many investors have now turned away from after being locked into cash during the GFC. Doug Chang, Head of Product, Macquarie Wrap