Road test: a product for the cautious

Co-founder of the Switzer Report
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I’ve been around many investment bankers over the years and have to admit that I don’t like structured investment products. With that bias out in the open and out of the way, let me turn to the latest sharemarket product from Instreet – the Instreet Mast Series 19 – a product that lets you buy into the S&P/ASX200 without any cash up front, but gives you an out if the index turns sour.

Who is Instreet?

By no means a household name, Instreet is a boutique Sydney-based firm that was established in 2007 to design and distribute investment products to the retail market via financial advisers. Instreet Investments Limited (and its controlled entities, including the issuer of this product) had net assets of $4.9 million at 30 June 2011 and made a profit of $900,000 in 2010/11.

The product

The Instreet S&P/ASX200 product (Series19) allows investors to participate in an increase in the value of the sharemarket – with negligible cash outlay and a capped risk of loss. Essentially, it’s like buying a three-year call option over the S&P/ASX200, which with some re-packaging, also pays an annual coupon of 4% and has the potential for a much larger return on the maturity date.

The structure is known as a ‘deferred purchase agreement’. Your fund borrows the money from Instreet through a limited recourse loan, pays interest on the loan each year in advance, and on the maturity date, either repays the loan and takes delivery of an effective basket of shares, or just walks away! There’s no credit enquiry – and you don’t need to put up a deposit.

If the value of the S&P/ASX200 index increases over the three-year term, then your investment could produce a positive return – potentially a very positive return. If the index doesn’t grow by the required amount or worse, goes down, then you will lose some money, however your losses are capped.

The details

  • Your fund borrows the money from Instreet through a limited recourse loan. The loan is compulsory – you don’t put up a deposit;
  • The interest rate on the loan is charged at 7.90% per annum (pa). You need to pre-pay this at the start of each year (so if the initial loan is $100,000, the cash outlay from your fund in year one is $7,900);
  • You receive a coupon payment from Instreet of 4.0% pa for the first and second years – so you get paid $4,000 on a $100,000 investment/loan;
  • At the end of the third year, you may receive a final coupon. If the S&P/ASX200 has increased by more than 8% since the investment commenced, then you will receive a payment that approximates the increase in the S&P/ASX200 as though you had invested $100,000 in the market. If the increase is less than 8% (or negative), you get no final coupon;
  • If there is a final coupon, you repay the loan and take delivery of a basket of shares, which in this example is worth $100,000.

The cashflows

For a $100,000 investment, the cash flows are:

There is a volatility overlay, which increases or decreases the final coupon by a ‘participation rate’. The rate is 100% if the daily volatility of the S&P/ASX200 over the period is 15%. That is, if the share market is less volatile and the measured volatility is say 10%, the factor is 150%; if the market is more volatile, the participation rate falls below 100%. The participation rate as at the date of the product disclosure statement (PDS) was 88%. Typically, volatility falls when the market trends higher in price, and rises when the market falls – so the overlay potentially works to smooth the return and boost a positive return.

Who does the product suit?

SMSFs can invest in this product because it is a limited recourse borrowing arrangement (LRBA). Given there is almost no initial outlay (apart from the first year’s interest payment), it is more suited to a fund that is fully invested in term deposits or property and has negligible exposure to the sharemarket and wants some upside protection. Think of it as a little like buying insurance, not for a downside risk, but for an upside one

Making money?

Assuming a participation rate of 100%, no adviser fees and ignoring the time value of money, the sharemarket has to increase by around 23.7% over the three-year period for you to break even. With the S&P/ASX200 currently around 4,300, this means increasing to 5,300. Below this level, you will do your dough.

If the S&P/ASX200 reaches 6,000 in three years’ time, your final coupon will be around $31,600 – taking the net profit on the investment to around $15,900.

On the downside, the loss is capped at a maximum of $15,900. However, there is an innovative feature that allows you to ‘walk away’ from the investment without penalty on each anniversary date – so if the sharemarket bombs, you could bail with a loss of only $7,900 at the end of the first year, or $11,800 at the end of the second year.

My view

This is a very complex investment. The analysis above barely touches on some of the nuances with the product. There is an old adage in markets that goes, “if you don’t understand something, don’t invest in it,” so if you’re considering investing, this is an investment where you must read the PDS closely.

This product is not for me. That said, it does meet a need for those who need insurance for the upside; losses are capped, and it offers an easy and relatively low entry point to the market over the medium term.

Instreet also offers deferred purchase agreements on the US market through the ‘S&P 500 (Series 20)’, and commodities through ‘Absolute Return from Commodities (Series 21)’ product.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

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