As volatile markets continue to batter investor portfolios and confidence, advisers are seeking out alternative investment vehicles to offer as comfort to their clients.
One avenue many advisers are taking on behalf of their clients, and in some cases many advisers are revisiting, is that of capital protected products.
"Coming into this year, we've definitely seen a change of attitude from clients. Obviously their cash returns have had a big effect on what people do, and when people could tuck their money away at 8 or 9 per cent last year [they did so] quite easier with very little risk," UBS structured product sales head Mark Small says.
"They are now coming to roll that over and are finding that those rates are 4 per cent or less, and so they are turning back to the equity market and back to capital protected/structured products to work out ways to try and generate more revenue out of their investments."
JPMorgan Australia vice president of equity derivatives and structured products David Jones-Prichard agrees.
"Ultimately we're very confident in the market for capital protected products. We think that this downturn has really highlighted the value in capital protection," Jones-Prichard says.
"Capital protected products for the most part have substantially outperformed the underlying market for 2008, and it was not long ago that a lot of people were saying why do we need capital protection, and I think 2008 has well and truly answered that question."
The resurgence by advisers and their clients to use these products has not surprised CommInsure executive manager of super and investments Carly O'Keefe.
"What people want now is certainty and these products offer certainty of capital protection and they offer certainty of income," O'Keefe says.
"So it's perfect now in times like this because people are really looking for certainty."
For Axa general manager of sales and marketing Adrian Emery, continual market volatility has made it easier to educate advisers about capital protected products.
"What we've seen in the last four to five months has been a significant number of advisers registering to use the [North] product," Emery says.
"We've seen a significant increase firstly in the number of applications that we get and then that translates somewhere down the line into a significant increase in the amount of new business that we see come through, because obviously money needs to follow the applications."
Market impact
However, while the capital protected sector provides hope for investor confidence amid market turmoil, the sector itself has not escaped the financial downturn entirely unscathed.
For many product providers, falls in the markets have left them contemplating their future, while others have been forced to return to the drawing board.
"Last year obviously was very difficult for the structured product market and a lot of what had been issued previously performed poorly last year - there's no question about that. As did most investments in the market mind you," Small says.
"Looking in the last quarter of last year we found most clients pulled the shutters down and closed up business for structured products and that happened in about September, where most of the research houses and a lot of the financial planning outfits just shut their doors and said they are not doing anything more this year [2008]."
The falling market has also had an impact on the mindset of individual investors, according to Jones-Prichard.
"Generally they [capital protected products] will be popular in bullish markets as is any type of investment. At the end of the day these products will give exposure to a risky asset and for the most part, capital protected products require that risky asset to go up," he says.
"Now if investors aren't bullish on that risky asset then it doesn't really matter how they get that exposure. The exposure isn't going to perform. We are going to see more demand for these products as we would with any investment products in a bullish market."
As well as the market downturn influencing client and adviser decisions, the challenging market conditions shifted demand for investment products across the board in 2008, Macquarie Securities head of distribution Kurt Jeston says.
"We're now seeing an unwinding of that position with the top three opportunities over the coming year expected to be direct equities, index funds and capital protected products," Jeston says.
According to a new industry report commissioned by Macquarie, the "November 2008 Macquarie/Investment Trends Alternative Investments: Planner Report", the demand for capital protected products among advisers is expected to rise by close to 20 per cent.
"We're seeing an increase in demand for capital protected products with the Investment Trends survey showing advisers expect to increase their use of these products by 19 per cent in 2009," Jeston says.
"Advisers are polarised on their attitude to gearing - advisers either will or won't use gearing in the coming 12 months; no-one's sitting on the fence.
"While allocations to international and domestic markets are expected to remain unchanged, international exposures are likely to take a multi-asset approach."
In O'Keefe's experience, the downturn has also propelled advisers towards other retirement income stream solutions.
Advisers are now recommending retirement saving accounts (RSA) alongside capital protected products, she says.
"I've seen more advisers recommending RSAs now because it has the government guarantee and also capital protection," she says.
"Investors are getting really nervous so they are looking for different alternatives and advisers are looking for different alternatives, which is why they are thinking of RSAs when traditionally RSAs are more of a direct product."
On the other hand, Emery believes the downturn in the market has provided more opportunities for the sector.
"Each time we have a correction in the market or a downturn in the market, people want guarantees more and they keep them and when they want out and back into bull markets because they don't want to lose the money again. It's the psychology of 'I don't want to lose again'," he says.
"So once markets return we actually see these products even stronger in terms of new business flows for advisers than they were previously."
Competition
Despite market falls dampening the growth of the capital protected market, competition among product providers is still relatively strong.
"What we've seen in the last three or four years in particular is the structured product market in Australia has become much more competitive," Jones-Pritchard says.
"There have been new competitors arrive, there's been innovation of products and those two things combined have meant investors are now getting a much cheaper priced product than they would have three or four years ago."
In fact, he believes the current range of capital protected product providers is catering to the needs of the investor.
"Yes I think they are. I think because of the large number of issuers in the market who are all trying to create products which serve their investors' needs," he says.
"I think we're seeing more and more products, it's a larger set, there's more innovation and through those increased number of issuers and increased market knowledge for the issuers I think we're collectively creating a better product set and a more diversified product set to cater for the needs of all investors that want to buy structured products."
To a certain extent, Jeston agrees.
"While the current range of products is mostly meeting investor needs, we're likely to see new product solutions evolve to meet the demand for greater simplicity and transparency," he says.
Meanwhile, Small takes a polarised view, suggesting competition in the market will diminish in the coming year.
"I certainly think the number of competitors in this market that we face will have diminished due to what happened in 2008," he says.
"So we are certainly seeing issuers pulling back from a very aggressive issuers' profile, pulling back to a more conservative [stance]. Clearly there is just less activity.
"So we are finding that one of the reasons that we are getting such a strong response now [is] we've got advisers who are looking for opportunities for their clients and there's not that many [opportunities] out there anymore."
Fees
The fee structure of a capital protected product has been a priority for Axa, Emery says.
Due to the varying level of investor profiles of clients, Axa's fee structure in its North product has been designed to provide the cost of the guarantee.
"We've got a whole range of clients with different investment portfolios and different terms, so we tend to bucket them," Emery says.
"You couldn't have individual pricing for each client, we tend to bucket them, and so when we set the fee structures we make some assumption about what future contributions would be, what withdrawals would be, because that is one difference with the North product over many of the other guaranteed products.
"We allow a great deal of flexibility in terms of making future contributions or in terms of clients taking money out."
He says Axa assumes what investment managers' clients will use and what portfolios they will use and then they come up with what the guaranteed premium will be.
"Then we use that to pay for the cost of the hedging of the derivative to match it. So other people may be able to come in and do it at a different price, but no-one has yet," he says.
"We've priced it we think so that we've got a very competitive product and so that we've got a very competitive platform, investment management structure and guarantee for clients."
Small says feedback from an adviser forum late last year enabled UBS to further understand the importance of a fair fee structure.
"The feedback was that people are now willing to accept lower risk, lower return type of products. They were put off somewhat by the higher cost of leverage especially when interest rates were high last year, but also the protection of capital protection products is very expensive at the moment and you can't get away from that," he says.
"Because of the volatility in the market, all the option prices that go with that protection have blown out to high levels. Now there's a reason for that. I mean high volatility means high risk but also high return if you get it right. And so you do get this in market crashes when the volatility spikes right up, but then there's a lot of upset potential if you get your call right."
New players
Axa and UBS are the industry's main innovators in recent times in the capital protected product space.
According to Emery, Axa's North product is the only product of its kind in the industry.
"Other products use a thing called CPPI (constant portfolio protection insurance), which is effectively in falling markets you sell assets into cash and in rising markets you sell out of cash, and that kind of institutionalises what we think is poor behaviour by investors," he says.
"Clients are always told don't sell into a falling market and buy into a rising market. North doesn't do that; North leaves clients fully invested at all times and we charge a premium to provide the cost of the guarantee and of course the cost of that guarantee depends how aggressive your portfolio is in terms of growth assets and how long you want the guarantee to run over."
Axa rolled out North in November last year, and despite the product's take up being very strong, investors were initially sceptical.
Suggestions the product would allow investors to insure against investment loss over a minimum five-year term left many as non-believers.
"From a few people, yes, until we were able to point out to them that although this is new to Australia, it's not new to the Axa group," Emery says.
"We've been doing this for close to 20 years in other parts of the globe, particularly in the US, and it's the expertise that we've been able to bring from the States, which is done through a central hedging derivative trading platform that Axa has globally, that has enabled us to launch it into Australia.
"And once we were able to show the experience the clients and advisers have had, in different markets in the US, then a lot of that scepticism has gone away."
As well as offering North, Axa is in the development stage of offering guarantees around income.
"What we are considering and what we're looking at is can we provide some form of guarantee around income in retirement as well," Emery says.
"We do give people capital guarantees in their retirement planning, so they can take income and know that their capital is secured, so that works very well. A lot of advisers use that strongly in transition-to-retirement strategies that they have got. One development that we are looking at for 2009 is is it possible for us to provide guarantees around the income.
"It's certainly been done in the States. One of the differences we have here is around allocated pension structures and where your minimum withdrawals have to be, so absolutely it's possible. Whether you can get it to work in a different tax environment is the question we have to solve."
UBS launched the UBS Perles-plus product to market last week. The tailored product offers investors exposure to the S&P/ASX 200 Index and was specifically designed for a volatile market.
"The important thing to note though is that structured products are flexible and we can tailor them to any environment," Small says.
"So what we've done to this Perles-plus product is that we've actually tailored something here that takes advantage of the high volatility in the market and is aimed at people who want something close to a cash return, but also are prepared to take some risks. This is not a completely capital protected product. If the market falls by more than 35 per cent, you're not capital protected on this product.
"So you are taking some risk and in fact you're actually selling volatility and there is a number of products we can do to take advantage of high volatility markets."
Disadvantages
While capital protected products act as safeguards with investors' money, there are also a number of disadvantages surrounding the product.
"I guess the disadvantage really is you can't buy structured products on any asset. Structured products do give exposure to a lot of assets that retail investors, for example, wouldn't normally be able to get exposure to, so they are able to provide that diversity," Jones-Prichard says.
"But I guess with any product that gives some benefit, there has got to be some cost. And the cost, and it depends on the product, but you may not get the full upside, you may not receive all the dividends. Generally most products will charge a fee which is fairly comparable with most managed funds, especially for the international funds."
In a more specific case, for a product like UBS Perles-plus, the disadvantage is it cannot be used in a non-volatile market.
"The returns of a product like this will decrease as the market decreases. So it will remain viable while volatility remains high," Small says.
"We're likely to turn to something else that takes advantage of lower volatility when the market changes back that way."
Client demographics
Capital protected products best suit two types of investors: wealth accumulators and retirees.
"I think structured products really cover off two main areas. One is it allows investors to get exposure to an asset by leveraging into that asset," Jones-Pritchard says.
"I guess the two main types of investors that we see in structured products are investors who are in their wealth accumulation phase, and maybe have a high income, lived the good life, have not saved as much as they should have, and really need to start knuckling down and build their wealth.
"What we see with those people is that they want to get exposure to a growing market or rising market and they want to do so by borrowing money in a tax-effective way and getting exposure that way."
The other type of investor that predominantly uses this product is the near retiree, he says.
Jeston says the product does not need to be so age-demographically specific, with the product suiting an investor with a long-term investment strategy.
"While these products are typically suited to investors with a longer-term investment horizon, we're seeing an uptake in demand from investors who are looking for certainty over a 12 to 24-month time frame," Jeston says.
