Archive for December, 2007

Lies, damned lies and Nationwide

December 28, 2007

Nationwide have revealed their 2007 House Price Inflation (HPI) figures for individual cities:

Nottingham (-2% last year) has disappeared from the 2007 list while Aberdeen (+25%) has entered, very convenient!

Prices in major English cities have fallen in real-terms over the past two years: Birmingham, Manchester, Liverpool and Newcastle. The likes of Cardiff, Coventry, Leicester, Bath, Durham, Leeds and Northampton have managed HPI a touch above RPI. After upkeep costs where are the capital gains? Restricted to the upper-middle class and Celts it seems!

Decoding a SCARP

December 23, 2007

I’m fascinated by structured products as they effectively offer the consumer a “derivative play” in the form of a snappily branded package. The most recognisable type of structured product is the Guaranteed Equity Bond (GEB). GEBs are offered on the high street by banks and building societies and attract custom with the benefits of the stock market on the way up yet capital protection on the way down. This is an attractive mix but they are usually very poor products. have issued many informative articles about the downsides of these retail products in the past.: guaranteed equity bonds

SCARPs differ from GEBs due to the CAR bit, Structured Capital At Risk Products. SCARPs usually offer some capital protection in the form of a buffer. This buffer allows a certain fall in the value of the stock index, to which the SCARP is linked, before the investor’s capital is at risk. However, the loss can be devastating if the buffer is breached.

The now discredited precipice bond is a form of SCARP that was popular around the turn of the millennium. The main difference between older precipice bonds and modern SCARPs is a fall in the index needs to be far larger and over a longer time period for capital to be lost. Precipice bonds usually only require a 5% or 10% fall for capital to be put at risk. Newer SCARPs often require the index to fall over 50%.

SCARPs need to be looked at with a studious eye. Reading the small print is must, its a proviso with all financial products but one often ignored. While you’re unlikely to lose your capital with a high street product, with a SCARP not reading the terms & conditions could be very costly. SCARPs require a little decoding and good reading comprehension to understand them. Identifying the upside and downside of a structured product is far from simple but compared to the derivatives underneath the glossy packaging, they’re a cake walk. Here’s an analysis I performed on one such SCARP, the KeyData dynamic growth Plan Plus, at MSE.:

80% over six years is an AER of 10.3% capped.

Chance of losing money, in nominal terms is very, very low.

Post 1914 a 50% drop would have happened around 1929, 1974 and 2000-2002, so this would suggest a roughly 33/1 chance. However, there was a quick and sharp rebound in ’75 and we are nowhere near the bubble territory of 1929 or 1999. Also, a halving of the FTSE-100’s value in 2014 would put it around 1995 levels, a 20 year nominal capital value freeze has never happened, not even in the US if you’d bought on October 23rd 1929! So, its more likely 100/1 than 33/1, if I were a bookie I’d say fair odds are 66/1. Of course the old warning must be given here: past performance is not necessarily indicative of future returns.

A nominal return of capital would still be a fall in real-terms. Factoring in 4% RPI would mean a loss of 26.5% if the FTSE-100 fell <50% over 6 years or stayed the same.

The loss of dividend income needs to be factored in. A cheap FTSE tracker or equity income investment trust is going to pay out a dividend of 3.5% at the moment, so 23% (excluding dividend growth) over the 6 years. Therefore:

The FTSE-100 needs to see a capital gain of between 2.3% and 57%
a loss of >23.1% and <50.1%
for this SCARP to do better than a tracker over the six years.

The tax situation of the SCARP should be beneficial for most people, i.e. those who don’t have a Capital Gains Tax liability and can use up their allowance. Important to realise that the capital gains will be realised in the year of maturity so putting >£11,500 in would mean going over the current personal CGT allowance of £9,200 if the value of the FTSE-100 rose 8%+ in the six years. Of course the government could tinker with the tax rules and make the above meaningless.

Frankly, it looks a decent product to me. I think its worth a good look if you:
1. Are using your 7K ISA allowance.
2. Are paying a fair amount into a pension.
3. Want a relatively high return with some capital protection.
4. Don’t have the expertise to make use of the CGT allowance.
5. Aren’t prepared to pay an IFA for that expertise.
6. Are currently paying income tax on a large chunk (say 10K+) of change in a deposit account that you know you will not need in the next 6 years.

Note: I’m ignoring the 4%pa ‘bonus’ since you only gain interest for a few weeks before the money is invested, they don’t pay out until a week after the maturity period either. I’m also ignoring the stated 3% commission since this seems to be built into the calculations Keydata give.

See also:

FTSE Small Cap Collapse

December 21, 2007

The FTSE Small Cap Index[1] has nose-dived since September. A magnification of the falls on the FTSE 250, true. Yet this bares little resemblance to the Russell 2000 (the de-facto benchmark small cap index in the US). The Small Cap and Russell had tracked each others movements quite closely in recent years:

Russell 2000 vs FTSE Small Cap (5yr)

Key: RLT = Russell 2000, SMXX = FTSE Small Cap excluding Investment Trusts.

The divergence over the past three months is rather alarming:

Russell 2000 vs FTSE Small Cap (1yr)

Year-on-year the drop in the Russell 2000 is ~4% compared to >20% for the Small Cap! There are numerous possible reasons. I’ll posit a couple of those I favour.

1. Darling’s politically motivated attack on private equity via the 18% CGT rate could be partly to blame. Many long-term holders in smaller companies may well be locking in profits at the 10% rate. Crash Gordon’s pension raids have deflated the FTSE for the past decade so its no surprise Darling has carried on with the wealth-destroying traditions.

2. A realisation that Britain and sterling are screwed. While the US commentators are expecting a sharp “v” shaped recovery by late 2008 there seems to be no such relief for the UK. The UK is far more reliant on the property bubble, financial services and on the public sector gravy train. Anyone holding property or financial stocks already knows about the markets repricing. The public sector has gotten far too big and far too wasteful, a point reflected by Prof. Peter Spencer when commenting upon the latest government spending figures:

“What is really shocking about these figures is that they reveal that the Exchequer was running a large current deficit before the credit crisis hit home, when the economy was doing very well and it should have been showing a large current surplus”

This isn’t the place to have a rant about New Labour, but with the economy, or at least the perceptions of the economy, turning it is too late now. We’ve reached the top of the big dipper and the sudden dread of the fall to follow is beginning to dawn.

Evan Davis, while looking at the utterly meaningless trade deficit, opines:

The UK looks [as if] it has had more in common with the US than we thought.

Dear Evan, if only that were true!

[1] The FTSE Small Cap excluding Investment Trusts (ITs) is used in the charts as a more meaningful measure.