RBS Global Access Series

PORTFOLIO POINT: Physical “put options” at the heart of the RBS product provide capital protection and allow the investor to walk away at the end of each investment year.

Since the bad days of the GFC, investors looking for low-risk investments (maybe also with leverage and protection) have been swamped with products that provide a neat outcome for their issuers but leave investors with an inferior outcome.

Typically products issued during the “credit crunch” catered to bank providers who didn’t have any real money to lend; and couldn’t hedge or buy the traditional “put options” that were often used to provide protection prior to the GFC.

So it’s a positive signal for the market and investors to see the return of real share loan protection packages, with relatively attractive interest rates and costs, and efficient design and structuring. The new series of RBS Global Access Series is a good example of this development.

RBS Global Access Series (GAS) are issued as traditional instalment warrants. They provide exposure to a range of underlying assets, including ETFs such as the SPDRS ASX 200 and I Shares S&P 500 or FTSE China 25.

The instalments are ASX-listed and, unlike the proliferation of “synthetic” products being promoted, they actually hold these physical ETFs in a security trust that is part of the overall instalment warrant package. Limited-recourse finance of 100% of the value of the underlying ETF is provided for GAS investors. This package delivers at least three key benefits for investors:

• Since the physical shares are held, the actual dividends received on them can be passed through to the investor.
• When the instalment loan matures (eg, when the investor pays back the embedded loan within the instalment), there is no tax payable.
• When the investor does choose to sell the instalment or the underlying share/s, the tax payable is a capital gain and discount CGT provisions will apply.

Focusing on these three factors highlights the difference between “physical” and “synthetic” protected investments. As we have shown in previous articles (click here), synthetic investments are based on underlying derivatives such as call options, which don’t pay any dividends or cash distributions.

Our tax law only allows deductions for interest expenses where the investment produces regular income, so the synthetic products have to manufacture the cash to make these distributions. This typically happens in one of two ways: either some of the investor’s interest payment is recycled back as a cash distribution, or the investment is designed to buy a string of call options linked to the underlying assets, some which mature annually (and thus, if the market rises, these can pay an annual distribution), and some of which mature at the end of the investment. It sounds complex because it is.

The investor pays tax at maturity of a synthetic investment, and in most cases, the tax is at full rates, eg the profit (if any) is not treated as a capital gain. But when real shares or ETFs are used, like in the RBS GAS investment, the “maturity” of the investment simply means that the underlying loan is repaid – and just like paying off your home loan, this is not treated as a tax event (and when the investor sells the underlying share, if ever, only then is discount CGT payable).

Physical “put options” are at the heart of the RBS GAS investment and create the capital protection mechanism. These not only provide 100% capital protection, they also allow the investor to “walk away” at the end of each investment year.

The cost and availability of put options has improved significantly as volatility receded, and RBS has designed an innovative mechanism to further reduce their cost. RBS lends investors an amount equal to their estimate of the dividends to be paid on the underlying investment during the forthcoming year.

If ASX 200 dividends are estimated to be (say) 4.9% for the next year, RBS will add that to the loan amount; for example, the investor will in total borrow 104.9% of the value of the underlying stocks in year one. In return, the investor has to pay the dividends over to RBS in return for which RBS offers a lower overall interest rate for the GAS instalment. The investor does receive the dividend for tax purposes and is entitled to the associated franking credits.

Using this mechanism, RBS is able to offer relatively attractive interest rates (note these rates are paid on the entire loan amount – including the amount lent on account of the future dividends):

• 11.3% pa for ASX 200 ETF exposure
• 11.75% pa for S&P 500 ETF exposure
• 13.4% pa for China ETF exposure.

RBS also offers “capped” instalments, where investors forego upside above 120%, in return for even lower rates:

• 9.85% pa for ASX 200 ETF exposure
• 10.45% pa for S&P 500 ETF exposure
• 10% pa for China ETF exposure.

Obviously this style of investment is primarily suited to an investor who has a positive view on the underlying asset. Since part of the investor’s interest cost is fully deductible (up to the RBA home loan interest rate 1% pa), the overall after tax cost is less than the notional cost (actual after-tax costs are determined by the investor’s applicable tax rate).

Unfortunately, the payment of the dividends to RBS in reduction of the loan interest rate are not treated as tax-deductible, so the receipt of these (for tax purposes) has to be added to the investor’s tax bill (but will increase the CGT cost base, helping reduce the CGT payable when the underlying shares are finally sold).

But the real – and often overlooked - investment opportunity with products like RBS GAS is that they allow investors to get exposure to (for example) $10,000 of the underlying asset for as little as $985 pa. That is great news for start out investors or for those wary individuals that like to reduce their investment risk.

RBS GAS are a welcome return to normality and should provide some good opportunities for investors with a positive view on investment markets.

The score: 4 stars
1.0 Ease of understanding/transparency
0.5 Fees
1.0 Performance/durability/volatility/relevance of underlying asset
0.5 Regulatory profile/risks
1.0 Innovation

Tony Rumble is the founder of the ASX-listed products course LPAC Online. He provides asset consulting and financial product services with Alpha Invest but does not receive any benefit in relation to the product reviewed.