What caught my eye this week.
A reader, John, emailed me about an old article this week. He pointed to a spreadsheet function could be used to calculate the cash component of a DIY guaranteed equity bond.
If you’re thinking “what’s that?” you won’t be alone.
That article was published in 2010. Memories of the huge financial crash were still fresh. Many people I knew were scared of putting new money into markets.
Enter the guaranteed equity bond!
Varitations of this financial product – widely-trumputed in swanky newspaper adverts at the time – promised to almost always return your money to you a few years hence, as well as giving you some of the gains on a stock market index.
Of course it wasn’t called the Almost Always Bond. But the small print contained strange catches and odd hurdles. These meant you could indeed get less back than you put in.
In addition dividends were usually ignored in the return calculation. And there was also little if any mention of the fees the financial provider would enjoy.
The bond was constructed out of derivatives contracts. Hence those specifics in the terms and conditions. I’d strongly suggest the target market for a product like this is poorly-placed to evaluate the odds of the FTSE 100 being above 8,235 on a particular day in March 2025, for example – as if anyone really can. But that implicit calculation was in the mix.
My piece explained how to create nearly the same thing for yourself from a mix of cash and a tracker fund. But with none of the complexity and opacity.
Shout
I considered updating my article for 2022, working in John’s technique. (John suggested using the CUMIPMT function from the free LibreOffice spreadsheet tool, if you’re curious).
But then I realized it has been years since I’ve seen an advert for a guaranteed equity bond.
I’m sure they still exist. But back in 2010 they were ubiquitous!
Perhaps there is a role for such a product – if appropriately demystified for the average person.
But what drives the marketing of them is clearly customer demand, not present utility.
Head Over Heels
Last year saw stock markets hit high after high. Remember all the articles about peak US valuations and a tech stock bubble and the general mayhem and euphoria?
If there was ever a time to consider investing in a product that capped your gains in exchange for protecting you from at least some of a crash, this was it.
But I don’t remember the financial services industry riding to the rescue with a marketing blitz for guaranteed equity bonds.
Doubtless it knew punters wanted more excitement and risk in a bubbly market. Not a crash bag.
Mad World
Should shares continue to turn down with rate rises, inflation, and war, then eventually we’re bound to see another moment in the sun for products that promise investing alchemy.
As Josh Brown puts it:
As you’re reading this, someone is hard at work in a lab somewhere cooking up the next big idea in Upside Minus Downside technology.
It might be an ETF. It might be a hedge fund. […] A structured note.
Who knows what form it could take next time?
The details will change, the wrapper will seem revolutionary, but the underlying idea will be a story as old as time.
And it will captivate the minds of some of the most intelligent people around. Doctors, lawyers, bankers, brokers, scientists, builders, politicians. None of us are completely impervious to a story that good.
Have a great weekend!
From Monevator
It’s not fair! Sequence of returns risk – Monevator
InvestEngine review – Monevator
From the archive-ator: Never say never again – Monevator
News
Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!1
Bank of England hikes rates to 0.75%, expects inflation to hit 8% soon – Sky
Treasury considers advice/guidance reform – CityWire
Men’s suits dropped from inflation basket, antibacterial wipes added – ThisIsMoney
HSBC to close these 69 branches in 2022 – Which
Buffett’s Berkshire Hathaway breaks above $500,000 a share – CNBC
UK can eliminate Russian gas this year, study finds – Guardian
Forgotten bank account pays out 60 years later – BBC
Covid resurgent in UK with infections in over-70s at record high – Guardian
Great Depression or bust – Of Dollars and Data
Products and services
Netflix plans to start charging for password sharing, running trials – NPR
The best deals on Cash ISAs (but they won’t beat inflation) – ThisIsMoney
Open a SIPP with Interactive Investor and pay no SIPP fee for six months. Terms apply – Interactive Investor
Nine ways to cut your household bills – Be Clever With Your Cash
Amazon credit cards to change from 2023 – Which
Time-limited offer: open an account with InvestEngine via our link and get £25 when you invest at least £100, PLUS additional cashback when you invest £1,000 or more in an ISA (new customers only, T&Cs apply) – InvestEngine
Could a 0% balance transfer credit card help you clear debts? – ThisIsMoney
Homes for sale from the 1960s, in pictures – Guardian
Comment and opinion
Why I’ll never buy an active investment fund again [Search result] – FT
Managing uncertainty, the biggest risk of all – Advisor Perspectives
How to crack HMRC’s tax codes – ThisIsMoney
In case you’re wrong – Humble Dollar
Name that fund manager – Quietly Saving
Life’s a circus – Humble Dollar
Budget to beat the rising cost of living [Podcast] – FT Money Clinic
Extremely bad decisions – Behavioural Investment
Tom Brady, retirement planning, and retirement remorse – Forbes
What does the global debt overhang mean for interest rates? – Joachim Klement
How to make $400,000 on a single real estate investment – Banker on FIRE
Liquidate – Indeedably
The art of money – The Root of All
Recession risk mini-special
Rising recession risk [US but relevant] – Pragmatic Capitalism
Surging oil prices have economists worried – Full Stack Economics
Predicting the next recession [US but interesting] – Calculated Risk
Risk of UK recession grows despite January boom – Evening Standard
Crypt o’ crypto
Ukraine partners with FTX and Everstake for crypto fundraising – The Block
NFTs have crashed but don’t despair – Howard Lindzon
The Bored Ape Yacht Club’s deal for CryptoPunks is all about IP – Protocol
Naughty corner: Active antics
5×2 matrices that can help you become a better investor – Validea
Cliff Asnes: value stocks not just an interest rate bet – Institutional Investor
Which analysts to follow – Klement on Investing
Wise words from Walter Schloss – Novel Investor
Kindle book bargains
Posh Boys: How English Public Schools Ruin Britain by Robert Verkaik – £0.99 on Kindle
Poverty Safari: Understanding the Anger of Britain’s Underclass by Darren McGarvey – £0.99 on Kindle
Hacking Growth: How Today’s Fastest-Growing Companies Drive Breakout Success by Sean Ellis and Morgan Brown – £0.99 on Kindle
The Almighty Dollar: Follow the Incredible Journey of a Single Dollar to See How the Global Economy Really Works by Dharshini David – £1.89 on Kindle
Environmental factors
Growing the Pie: a different take on ESG [Podcast] – Rational Reminder
Electric planes are coming sooner than you think – Afar
Great Barrier Reef hit by sixth bleaching event – Guardian
Off our beat
Slobbing out and giving up: entering ‘goblin mode’ – Guardian
The global oil market is based on a fiction – The Atlantic
Putting ideas into words – Paul Graham [h/t Abnormal Returns]
Children of Men is really happening – Wrong Side of History
Reassessing the women of The Godfather at 50 – BBC
Put yourself in their shoes – Spilled Coffee
And finally…
“Perhaps there’s no better act of simplification than climbing a mountain. For an afternoon, a day, or a week, it’s a way of reducing a complicated life into a simple goal. All you have to do is take one step at a time, place one foot in front of the other, and refuse to turn back until you’ve given everything you have.”
– Ken Ilgunas, Walden on Wheels: From Debt to Freedom
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It’s only fair that you reposted the sequence of returns piece this week.
I started reading Monevator in 2013, in my mid 20s as I started to save a bit in a sipp. This was one of the first posts I absorbed and I loved the idea that accumulation phase is largely immune from the sequence risk. NN Taleb has thought a lot about this, too, often elaborating on the difference between ensemble and sequence risk. I surmised I could actually put these market gyrations to good use, by upping the savings rate during market dips, such as the 2015 taper tantrum.
Today, the sequence of returns risk is a cause of worry. My nest egg accumulated slowly but surely. Then, last year, I suddenly received a million quid when the company I work for was acquired. I got half on the sale date, and the rest in three yearly instalments.
There are other posts here on what to do with a windfall (just put it in the market over a number of months). But what if we’re really at the end of a global debt cycle (see Dalio), dollar loses reserve status, nuclear war comes, pandemics arise more frequently, etc.. with the market at crazy valuations, and quite a nice stretch of life ahead of me, am I not supremely exposed to sequence risk? I was nearly 100% equity, but have recently started to reshuffle towards the golden butterfly portfolio (Portfolio Charts) with a BTL property thrown in. I’ll also come back and read the comments here more often, as it’s much easier now to relate to all of you in the decumulation phase!
Slight typo on the Kindle reads – it’s Darren McGarvey, not McGarbey
Congratulations on entering the Second phase of investing so young ie made”enough”
Once you have won the game stop playing-someone said
You sound as though you have learnt the lessons well
Long road ahead to retirement and de accumulating-can you avoid tinkering?
Well done so far
xxd09
As a former structured equity deriv trader who had a book full of these products it was always interesting just how little penetration the products had in the UK. Most of our London business was Europe facing (Sw/Fr/Ger). Any business we did in the UK was at eye watering margin (for the distributors) through a number of intermediaries before it ended up with an end client. Selling into Korea where the products were sold into retail bank networks in huge volume again highlights the cultural differences out there re structured products.
The simplest bond+call structure is doable without much fuss as a lone investor (like your article). You are using interest foregone on cash to pay for equity upside. Work out NPV of the return 100% of your notional in xx yrs time at whatever interest rate you can get and deposit this %of notional in said account. Use rest of money (100%-this value) to purchase same expiry call option in as much notional as you can. The cash accumulates the interest to get up to 100% notional so you get your money back (hello counterparty risk), the call option is the juice.
No replicating the more exotic structured products that are out there though. Clients selling worst-of puts on multiple underlyings to fund the upside / autocall features etc. All effectively taking positions on the whole gammut of greek letters that a retail investor has no insight into but in a competitive market where you get it at close to ‘fair’ value they can ‘work’ for the end investor. In this country where low volume means high margin I wouldn’t touch with a bargepole.
@WilliamIII
If a nuclear war cometh and we seriously start to lob hydrogen bombs around I do not think there is any point in holding cash, stocks or bonds. Best hope you are in New Zealand and you own a shotgun, lots of ammunition, and some tinned foods.
@WilliamIII Yes, decumulation is a far more complicated business isn’t it. I too have started meandering into the direction of the golden butterfly, though can’t quite convince myself to go the whole hog. Though even a 5% allocation to gold has been a real winner of late. It won’t last, but then that’s the point I suppose.
Meanwhile, bonds seem to be in the process of being beaten up at present, so hopefully soon will be time to move there too. VGOV (UK) -11% from all time high, VAGP (World) -8%, Vanguard Long duration -15% approx.
@TI – Bonds being down more than equities at present seems like quite a watershed to me, though I’ve not seen much written about it. Where are all the ’60/40 is dead’ articles? 😉
@all – anyone have the foggiest why a World tracker is up 4% this week and Nasdaq up 8%?
I’m seeing reasons from the Wall St Journal like: “Analysts also pointed to a positive tone from the U.S. central bank, where officials this week voted to lift interest rates in an effort to slow inflation.”
A fully anticipated and rather meagre interest rate rise in the face of red hot inflation sounds to me like an incredibly limp reason for a market rally. But, hey, I’ll take it.
@far_wide – I think comments that the likely interest rate peak is going to be lower than had been priced in. Hence Nasdaq increasing more than a world tracker.
> Electric planes, like electric cars, rely on battery-generated electricity for power, rather than standard liquid jet fuel.
Batteries don’t generate electricity. It would take the entire output of Sizewell B 1.5 hours to recharge a 747 with the equivalent of nearly 2GWh represented by the 184,000 litres of kerosene in the jumbo’s fuel tanks.
So no. Electric planes aren’t coming sooner than you think for tourist flights. They will appear, after all what are drones if not electric planes?
The average daily output of the National Grid for last year was 31GW according to gridwatch, so in 24 hours that’s 744GWh. So that’s ~370 jetliner departures a day. Forget all the electric cars, heat pumps, that is the entire output of the NG going to aviation, the UK won’t even have traffic lights.
Heathrow has an average of 1300 daily aircraft movements, half of which need to be fuelled. So it would need somewhere between all of the UK’s output and twice, depending on the mix of ranges between short and long haul.
So even if your fairy godmother magicks up all these electric planes tomorrow, where are you going to plug them in? Not only that, the kerosene jetliner gets lighter as it consumes the fuel – it drops by more than the weight of the self-loading cargo on a long-haul flight.
It ain’t gonna happen any time soon at scale. It may happen in short-haul, but the planes will be smaller and it will be dearer. People will have to fly less and/or pay more. It’ll be hard enough to decarbonise the existing power system, nevermind upscale capacity by five to 10 times to cope with the heating load coming off gas, and all those electric cars…
xxd09: indeed, we count ourselves very lucky. I much prefer the slight worry of sustaining a pot of money in the market, to the stress of parenting a couple of under 5s while both holding down demanding jobs..
ermine: Yes, aviation looks like the least likely sector to decarbonise to me. On the EV front though I think we only need to go back to 2002 levels of generation to support the whole fleet moving to EV’s.
William 111
I understand where you are coming from as a mere male myself with the ability to only do one job properly at the one time-worrying about Johnnys tea and clean clothes while trying to hit the woolly mammoth in the eye with a spear doesn’t work-get that spear throw wrong and you are toast!(plus no tea for Johnny!)
Had 3 kids myself and my wife enjoyed 10 years out of the workplace multitasking with them as they learnt to walk talk etc before they went to school
Perhaps this is an alternative available via your current happy situation that she could now chose if she so wishes-you might be surprised!
xxd09
That Tom Brady link, of his ‘unretirement’ was good, giving a multi-million dollar take on the ‘one more year’ syndrome.
I too saw the pandemic lockdown as a fire drill for FIRE – aside from not being able to travel and see my friends when I wanted to, I thought I coped quite well. I didn’t take up various new hobbies only because I continued to wfh full time but there’s a list of stuff I want to try out when I’m not longer working.
Ps – cheers for adding my post!
I once worked on a project for a large European investment bank which quite possibly was the same one that @Ducky worked for! The project involved upgrading their risk systems and turned out to be a project from hell. The equity derivatives system had thousands of wierd and not so wonderful structured products, along with other more mainstream (and not so mainstream) stuff. Pricing these things can be horrendously complex. Many of them have path dependant outcomes, ie the maturity value depending not only on the final values of the underlying(s), but on whether price barriers were breached along the way. The only way things like that can be priced is numerically, eg through binomial trees or Monte Carlo.
The idea that a retail investor or IFA would have any clue at all as to whether the price being offered was fair is laughable. If someone has added a few of these structured products to their portfolio they (or their IFA) would also have the ongoing problem of not knowing how much risk they were taking as the price of the underlying, etc. changed.
My personal view is that selling structured products to retail investors should be banned as they fly in the face of much of the spirit of MiFID II.
If someone does want a limited downside investment, then @TI’s approach is definitely the way to go. Easy to price at any time and with understandable risk. The whole thing is ISAable as well.
The problem a retail investor would have with @Ducky’s DIY suggestion would be in buying the call option. For a 5 year call, this would need to be OTC and a bank would not sell a retail investor a 5 year option without the investor jumping through a lot of regulatory hoops. The investor would need deep pockets as well – I doubt any bank would be interested in selling a one off call for less than £50k.