Guaranteeing against losses
It’s 2002 all over again. Wealth managers are scrambling to get their gunshy clients bank into the market by guaranteeing them there will be no losses, or at least only a few. They did the same thing after the internet bubble burst.
With many investors still reeling from the November 2007 to March 2009 equities crash, capital protection or guarantee plans are making a comeback. They generally work like this:
1) An asset is chosen, perhaps a basket of something. 2) A guarantee is ensured by investing a high percentage of the principal in paper — such as a discounted zero coupon bond — that returns all the principal by the end of the product’s life. 3) The remaining money from the principal pays for options up to the full amount of the principal on the underlying asset.
The result is that if the asset rises the options kick in and the returns are made. If it doesn’t nothing is bought and the principal is returned by the maturing paper.
All well and good, but at the moment there is a particularly ironic problem for the wealth managers. They are touting these products to get scared investors out of cash, which has precious little yield.
But they are equally not finding it easy to get the yield they need to guarantee of the principal.