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How to make 8% a year in a flat market

02 May 2019

Structured products got a bad name in the financial crisis – but FE Alpha Manager Tom May says it is just a question of managing expectations.

By Anthony Luzio,

Editor, FE Trustnet Magazine

Fund managers aren’t exactly shy about talking up their asset class, which is why many veteran investors have learnt to take their proclamations with a pinch of salt – someone who highlights the unprecedented tailwinds and extreme value in their chosen market may well be right, but this is often the same person who said exactly the same thing 12 months earlier, just before their fund tanked 40 per cent.

However, FE Alpha Manager Tom May (pictured) doesn’t like talking about the upside in his £932m AHFM Defined Returns fund, saying “this takes care of itself”. May believes managing clients’ expectations is just as important as performance, adding that what worries him is not a 2008-style crash, but investors buying into his fund for the wrong reasons.

“What keeps me up at night is people don’t engage enough with me when I say ‘you might go in the red’. They say, ‘oh your performance has been really good, you have outperformed the FTSE, I will buy that’. It is like, ‘no, don’t buy it for that reason, buy it because it is going to do what we say it is going to do’.

“It worries me that people might buy it based on past performance or buy it for the wrong reasons. But I never worry about my decisions, because I have told you already what we are going to do.”

He added: “I had a meeting with a client a little while ago, and he goes, ‘your USP is that you do what you say you are going to do’. And I was like, ‘do you know what the U in USP stands for? It stands for unique. And I hope we are not the only ones who do what we say we are going to do’.

“I didn’t put these words in his mouth, but he said back to us: ‘Well, that’s refreshing. You are quite upfront and honest about it.’”

AHFM Defined Returns aims to deliver a yield of 7 to 8 per cent a year to investors through holding a basket of structured products. However, May doesn’t like the term ‘structured product’, preferring a colleague’s description of “a bond with bells and whistles on it”, or even better, “a thing”.

“People can’t say ‘I hate structured products’ or ‘I love structured products’ because all they are is a way of expressing your view,” he continued. “A mortgage-backed security is a structured product and so is the stuff we do. But they are completely different.

“So first of all, when you hear the term ‘structured product’, chuck it out the window and translate it into the word ‘thing’. Because you can’t like or not like anything called a thing; it is just a thing.”

The “things” May uses in this fund are autocalls, which are bonds with an equity overlay.

An example holding is a Gilt-Backed FTSE 100/Eurostoxx 50 Defensive Autocall (8.00%), purchased for £1 on 18/06/2017. One year later, if the FTSE finished above 7463.54 and the EuroSTOXX 3543.88 (their starting level when purchased), the £1 would have been returned, along with an 8p coupon, leaving May to reinvest the money.

Source: Atlantic House Fund Management

As it happened, while the FTSE finished above the strike price, the EuroSTOXX was lower, which meant it rolled over to this year and so will pay £1 plus a 16p coupon if both indices finish above their pre-determined levels in June.


“If not, roll on to year three,” continued May. “Same thing. If not, roll onto year four. That’s June 2021. Now in June 2021, this is where it starts getting slightly more interesting. Those barrier levels drop a bit, so you have got a bit more protection to getting back your 8p per annum. Then you have a little bit more protection after five years.”

It is the sixth year that is the most important, as this is when the product finishes and the capital is returned whatever happens. However, while the investor will receive their original £1 outlay plus a 48p coupon if the indices finish above 63 per cent of their starting levels – so 4,714.42 for the FTSE and 2,243.28 for the EuroSTOXX – they will receive just £1 if either index finishes below 63 per cent of the starting value but above 60 per cent. Anything below that and their original capital will be eroded on a one-for-one basis.

“Now I contest that isn’t complicated,” added May. “Imagine you draw a probability cone. Low volatility means a narrow cone: it means not very much change up and not very much change down.

Expected performance of fund

Source: Atlantic House Fund Management

“That’s quite good for this trade because if there is not much up or down, you always get the green bit [the original capital and the coupon]. If you’ve got a big wide cone, down a lot is bad. Up a lot doesn’t matter as you still only get the green bit. So that means if expectations of volatility go up, the price drops as well, because of course the models think there is more chance of getting the momentum. There is more chance of going up more, but who cares because you have capped out your return.

“That’s the thing that moves them, plus volatility, plus equity markets. That is it, that is my career distilled into five minutes.”

The manager pointed out that the FTSE 100 has only moved up from 6,600 when he joined the industry in 2000 to 7,400 today, conditions under which his fund would have worked well. However, he warned that if there is a depression or something similar to what hit Japan in the 1990s, it will be a different story.

To help manage clients’ expectations, May uses models that will offer an idea of how the fund will do in certain scenarios – so if the market is down 20 per cent over one year, he estimates the fund will be down 13 per cent over that period.

“I always say, knock 3 [percentage points] off that, just to give yourself a bit of a cushion – I tell you what, we are definitely not up,” he said.

“We are definitely down. And I want you to know that. If the market comes back to where it is now over three years, so if goes down 20 then it crawls back, we’ll be down 13 per cent, then up 21 per cent.

“But if people know about the red numbers… I never talk about the upside with this stuff, because it just happens, it takes care of itself, the downside is what matters. If people get comfortable with the downside, that’s fine.”


He added: “That’s how we think about things, really clear, really transparent. This is it, warts and all. Tell you there are red bits, tell you what can go wrong. And don’t hide behind that. Is this a panacea? No. It’s just a way of trying to earn 7 to 8 per cent.

“You might like it, you might not. But as long as you understand it, I’ve done my job. I would rather you understand this trade and not buy it than not understand it, then buy it like they all did in the credit crunch, because then the whole market gets a bad name.”

Data from FE Analytics shows AHFM Defined Returns has made 46.65 per cent since launch in November 2013 compared with 38.27 per cent from its IA Flexible Investment sector and 37.68 per cent from the FTSE All Share.

Performance of fund vs sector and index since launch

Source: FE Analytics

It has ongoing charges of 0.72 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.