In this episode of Ghost Stories, The Finance Ghost sits down with Investec’s Brian McMillan, fresh off collecting the “Best Issuer in Africa” award in Stockholm on behalf of the Investec Structured Products team. The team’s product innovation and ability to earn a place for structured products in modern portfolios is being increasingly recognised.

The latest such product example is the Investec Nasdaq 100 Geared Growth structure. With much debate around the market valuations in this tech-heavy index, this structure is designed to appeal to investors who are finding it difficult to balance the desire to get involved against the risk of being late to the party.

Through a combination of 1.25x geared upside (with a cap) and partial downside protection (a drop of up to 40%), the Investec Nasdaq 100 Geared Growth structure creates a fascinating risk-return profile. 

Key topics covered:

• The choice of the Nasdaq 100 index at this stage in the cycle
• The underlying themes in this index across AI and valuations, including reference to the bull and bear cases
• How geared upside (1.25x) with a 60% cap works
• The downside protection mechanism
• Rand-denominated exposure and removing USD currency risk
• The Flexible Investment Note structure and reinvestment mechanics
• Liquidity via the JSE listing and daily pricing
• An understanding of the underlying credit risk
• Fees and why returns are quoted net of costs
• Minimum investment and access via advisors, stockbrokers and EasyEquities

You can find all the information you need on the Investec website at this link.

Disclaimer

Listen to the podcast here:

Transcript:

The Finance Ghost: Welcome to this episode of the Ghost Stories podcast. I always thoroughly enjoy recording with the Investec Structured Products team, because not only do they bring a lot of cool stuff to the show and some very clever thinking, but also just a fun team, I must say. 

Brian, we’ve had some excellent chats pre-show here about your recent trip to Europe, and I’m going to mention why you were there because it’s relevant. You were accepting an award on behalf of Investec Structured Products, from Structured Product Intelligence for the Best Issuer in Africa.

Well done. That’s all I can say, really. You guys have won a lot of awards. Are you bored of winning now, or is it still exciting?

Brian McMillan: Still exciting, especially if they have them in exotic places like Stockholm, which I’d never been to before, which was very nice. They look at volumes and they look at innovation. So, it’s not just who sells the most structured products, but it’s around the innovation and what we bring to the market.

The Finance Ghost: Absolutely. Well done. And we are here today to talk about something else that you are bringing to the market, and that is related to the Nasdaq 100. 

So, the official name is called the Investec Nasdaq 100 Geared Growth. And as always with your products, the name tells us a little bit about what’s in there, and we’ll obviously dig into that. But the elevator pitch is that it’s geared upside with a cap, as well as downside protection to a point. 

Interesting payoff profile, it does very cool things in the middle, for want of a better description, within a reasonable range of possible returns. 

You have to give up something on the extreme up and the extreme down, and then you get some interesting outcomes in the middle. That’s the wonder of structured products, right? It’s a set of trade-offs all the time, something that you guys are very used to structuring and doing.

Let’s just start with the underlying index. The clue is in the name, right? The Nasdaq 100. The Nasdaq has very much been the talk of the town.

We had the software-as-a-service, or SaaS, era about 10 years ago maybe, where those companies were suddenly just coming through. It was cloud and now it’s AI infrastructure.

Whatever’s going on in the world seems to happen in the Nasdaq 100. It is a very exciting index.

But what made you choose it now for the latest Investec structured product? Because one thing I’ve learned about you: the timing is never an accident when it comes to these things. You pick these indices at a particular time for a particular reason.

Brian McMillan: The Nasdaq has been something, and it is the first time that we’re using the Nasdaq 100 as an underlying to our structured product. It’s obviously very topical because it’s very tech heavy. About 66% of the index is in technology.

There’s been a lot of talk about AI. Is it a bubble? Is it worth investing in? Where the structured product comes in is, because it offers downside protection, it’s actually something where, if people are looking at that particular market and maybe perhaps have missed out a little bit – is that something that will allow them to go into the Nasdaq knowing that if there is a correction on the downside, they’ve got the protection, but also gives them that upside in a geared fashion to catch up? And that’s really the reason why we chose the Nasdaq. 

We’ve done so in rands. So, the thinking there, again, is that we’re quite bullish on the rand against the US dollar from that point of view. We’re happy to put out a product that is priced completely in rand and therefore only checks the percentage move of the Nasdaq. 

So, it doesn’t count the US dollar move; it counts the percentage move of the Nasdaq over that three-year, eight-month period.

The Finance Ghost: Yeah, that’s very important, Brian. Because normally when investing offshore, you obviously have to take into account the way the currency is going to move and the underlying assets. 

So, in this case you’re basically taking the currency out of it, if I understand it correctly, and you’re just testing based on how the Nasdaq itself moves. 

Brian McMillan: Yes.

The Finance Ghost: Maybe just talking a little bit more about that index and where it is at the moment, I suppose, versus historical norms. 

There’s a lot of chatter in the market about the valuations of these things. We’ve got the SpaceX IPO coming now. There’s some interesting commentary on that as well. 

It feels like a time where just taking, in my opinion, just going and buying the Nasdaq 100 without any protection, genuinely does feel like quite a risky play. I had to figure out what to do with my tax-free savings recently. 

It’s hard to justify ploughing it into something like the Nasdaq 100 at the current level without any protection, honestly. So, I guess that’s part of what’s informing this, right? You’re probably getting that kind of feedback from your clients as well.

Brian McMillan: They want to be involved, but they are scared: “Are we late to the party?”

Interestingly, those tech P/E multiples have actually experienced one of their largest corrections over the last decade. So, the software stocks, you saw them come down. 

And then on a forward basis, it’s actually not that expensive. It’s slightly above its average. The forward P/E is around 27 times. And that is because of this expected earnings growth coming through. 

So the semiconductor stocks, all of those in there, have this really high expected earnings growth. That’s why we’re looking at the PEG ratio, which is the P/E over expected earnings growth. And those are actually at historical lows. 

So, there is upside potential in these. They’re not massively overvalued.

And if we can offer upside on that – geared format, admittedly to a cap – it’s 1.25 times geared to a cap of 60%. So, we’ve given it space to run on the upside, and if it does go 60% over the next three years and eight months, you’ll get a 75% return.

But then we’ve also been a little bit more circumspect around the downside, where we are offering protection. 

The index at the end of the three years and eight months would have to fall by more than 40% before you actually have a loss, giving it more downside protection and then giving it the ability to run on the upside as well.

The Finance Ghost: It is super interesting, Brian. And I know from the brochure on this particular product (and because I could just go do the math, but it’s easy to read it from the brochure), if you do get the maximum return of 75%, then your guys’ calculations are telling us that that is a compound annual growth rate of 16.6% per annum. 

So that’s effectively the maximum that someone can get from this product, as I understand it.

And one thing I would say there, Brian, is that expecting more than 16.6% per annum from where the Nasdaq is right now – even taking into account what you’re saying about valuations and whatever – feels spicy. 16.6% – someone would probably take that right now, over the next three years, eight months. That would be my view at least. Obviously each person must form their own view, but that’s a pretty strong return, assuming that people get it. 

Again, I just want to be clear, that is the maximum upside. It is by no means the guaranteed return or that you will get that. It is the maximum you can get from this product.

Brian McMillan: That’s correct. That’s double what you would get in interest rate markets. So, from that point of view, we’re giving you the opportunity to earn up to double what interest rates would be around about now. 

To take part in this growth potential of the Nasdaq – you’re getting in there, you’re getting the software, you’re getting the hardware, the chip manufacturers, and then of course the AI. And nobody knows where that’s going to come out.

We’ve seen releases over the last year or two. Every time one of the major AI providers brings out a new model, it’s very exciting. The market runs ahead, there’s definitely potential there. We don’t know where it’s going to go. 

It’s also, as I say, it’s not too expensive. And one of the things I would say, we don’t think that this is a bubble in the traditional sense of the word, in that none of these companies that are building these AI models are actually borrowing to do so.

All that capex is being funded out of earnings at the moment, so nobody’s borrowing to pay those. So, while a lot of people seem to think just because the index has gone up so much that it could be in bubble territory, we’re not seeing that in terms of use of debt, which is traditionally where a bubble comes from.

The Finance Ghost: You certainly raised one of the bull cases there. They are funding it through – often advertising revenue, actually, if you look at the hyperscalers – or corporates paying them subscriptions, and that kind of thing, depending which hyperscaler you look at.

The bears will argue that a lot of this capex spend is being funded by investment from the providers of the product, creating this kind of circular reference inside the Nasdaq. It’s what’s making this so interesting, right, is that there are good bullish arguments, good bearish arguments as well?

My personal view is that AI is a complete change to the way we work. I don’t think this is just a hype story. I’m using AI more and more all the time. There are things that it’s really bad at, but there are things that it absolutely changes your life on.

And if you figure out those life-changing pieces and you use it to supercharge your work, then it makes a pretty serious difference.

I keep writing in Ghost Mail and elsewhere that you really need to be playing around with AI if you’re not doing it already. It is very, very important to do so. What that means from an investment perspective, time will tell.

The other bear case is that a lot of these cyclical stocks are now behaving like structural stocks. If you look at the memory stocks and those kind of things, they look cheap. But is it really the case that there isn’t just going to be another cyclical story? 

I don’t know. You don’t know. No one knows. And that’s the point, right? That’s why these structured products exist. Because the Nasdaq is an exciting place, but no one can be quite sure.

Brian McMillan: We looked at the Nasdaq over the last 25 years, actually a little bit longer, 26, 27 years ago, from the last dot-com bust. What’s interesting about that is there definitely was a bubble in 2000. Thereafter, the index did fall. 

But interestingly, when we compare it against some of the other indices in 2008, it didn’t have losses of more than 30%, where a lot of the other indexes, in fact most of the other indices that we use, did.

So, we took a view to give a little bit more downside protection. And what that means is that the index would have to fall by more than 40% from current levels, in three years and eight months’ time before you actually have a loss.

We think that we’ve built in sufficient downside protection. We understand that when the market actually did have that dot-com bust, the maximum loss was significant. And over a three-year and eight-month period you could have lost up to 72%.

But I think it’s very different from pets.com and anything with a dot-com at the end of it was being listed. There was no revenue behind it. I think this current market that we’re in is very different from that dot-com bubble. 

And just because it’s had a very strong run over the last couple of years doesn’t mean that it’s not on the back of real innovation and, as you said, real change to the way people work.

The Finance Ghost: Yeah, it’s a large part. I agree with that, honestly. It does feel like it’s not a silly thing. There’s a lot of interest in the space. I know a lot of business owners and corporates that are spending proper money on AI tokens.

It’s real; quite scary at times for the job market, but it’s real. And there’s going to be some things that happen, who knows, but it’s not going to go away. Of that I am pretty confident.

Brian McMillan: I urge people to go and get a paid version of one of these just to find out how easy it is to actually make use of the tools. I’m no spring chicken, but I’ve played around with it, and it’s very different from just asking ChatGPT what the best restaurant in town is. 

It’s really got valuable tools that you can use and it’s very easy to use. You’re seeing the companies now piling into these models, making use of them and spending real money on it. I think there is some upside in that side.

The Finance Ghost: And I just want to confirm with you the downside test, the upside test, it’s a point test, right? It’s three years and eight months from now. We’re looking once, we’re looking at what the index did, and bam, there’s an outcome. It’s not tested throughout, right?

Brian McMillan: So, for all of our products over the last 15 years, when we do that, we don’t have what you call this continuous barrier, where a Covid-like event could knock you out and then three months later the index is back again.

We only look at whether you made a loss over the entire term. So only on the last day.

We do have some averaging. Averaging makes it a little bit safer in terms of: we don’t have one day where you have to check it on. We use the last three months so that we have a little bit of a spread. We use the average over those last three months as whether the index is down more than 40% or, in that case, at more than 60%.

The Finance Ghost: That makes a lot of sense. Let’s talk about the flexible investment note structure that this sits inside. So that note actually has a term of 20 years, but it’s not because this is a 20-year investment. This is three years and eight months. 

My understanding is that there’s a way to then roll your exposure. At the end of this term, there’ll be a new structure that sits inside the investment note. And as an investor in the space, you could elect at that point to either participate in whatever that note is or to say, thank you very much, I want my money back. Is that an accurate understanding?

Brian McMillan: Yes, it is. That’s something that we’ve done for the last two years now. We issue a 20-year note. And the reasons around that are numerous. But what we have is that, thankfully, our issuances nowadays are very big.

We find that with using the flexible note, we don’t have the issue of having to expire a note, pay everyone their money back, and now the next one comes, can we get the money back from you again? From that point of view, it makes a lot of sense.

It allows people to remain invested if they wish to. So, we always make sure that everyone gets a chance to elect to remain invested for the next one. We make sure that they know what the risks are of the new one when this one expires.

And it doesn’t stop anyone from exiting should they want to. So there are a couple of advantages to it from that point of view.

The Finance Ghost: Yeah, it is a very interesting structure, and it certainly works really well based on your experience and actually some of the stuff I’ve heard in the market. 

You guys do have a good reputation in the market, for what it’s worth. They seem to be popular with investors. So, to your point, some pretty big flows these days. You’ve had to adjust structures accordingly, right?

Brian McMillan: We’ve been lucky. I think it speaks to structured products themselves. There was a lot of skepticism initially in structured products. And when I say initially, I’m talking about over the last 20 years. 

Things about would they pay off when they expire, how do they work, are there too many fees in them, are they quite opaque? And I think over the years we’ve dispelled a lot of those. People now know that when you invest in one of these, they do what they say up front. 

If the index is geared 1.25 times, the index goes up 10%, you get a 12.5% return. If it goes up 20%, you get a 25% return. And people like that sort of thing.

And then it plays into people’s natural fear and greed side of investing. It takes away some of that fear because we have that downside protection. And then it allows the upside, and it allows people to remain invested longer as well. 

A lot of people nowadays, they invest in something, it goes up 20%, they sell it, and it runs another 20, and they go, “I should have stayed in that. I shouldn’t be trading these things”. 

We keep people invested in the market where, over the last 15, 16 years, it’s been the place to be. 

The Finance Ghost: Speaking of staying invested: liquidity is something we always talk about on these. But let’s do it again if there’s any new listeners who aren’t familiar. 

Life does happen: to what extent is there a liquidity option before the end of the three years and eight months? And how does that work?

Brian McMillan: That was one of the first things that we had to address because structured products were this point-to-point, you bought it, three years and eight months later, you could sell it.

Nowadays we list all of our structures on the JSE or in Dublin. This particular one’s listed on the JSE. And when we do that we provide a daily price for these. The daily price means that we will buy back any of the structured products that we’ve got out in the market at fair market value with a 1% bid-to-mid spread.

We have that in there, and it’s available on a daily basis. So they become very much like shares. You can sell them should you need to. 

I think the only thing to note is obviously that the capital protection is only available at the end of the term. So, if we found, for example, that the index was down 20% after one year, that’s not to say that you could sell out and you would get back your full capital. It’s only at the end of the term. 

But similarly, if the index is up 20%, you would see a gain, but you wouldn’t necessarily see the geared upside because we make use of options in these, and those options only bring the full value of the gearing in towards the end of the period. But you can trade them quite freely from that point of view.

The Finance Ghost: Let’s also just talk about underlying credit risk. I know that’s one of the other things with structured products that people quite correctly ask about. 

Because at the end of the day there are a lot of underlying derivatives and other structures in place to make this thing pay off the way it does. So what is the underlying credit risk that an investor would be taking in this product?

Brian McMillan: The investor takes credit risk to Investec Bank Limited, and we are the issuer. That’s an important thing. 

You wouldn’t buy a structured product issued by Brian McMillan because you don’t know he’s going to be around in three years and eight months to give you the money back. So the issuer is the most important credit risk. And as you mentioned, Investec Bank in South Africa has a very good name. So that’s the first credit risk you take.

We then add a credit risk of Barclays PLC onto this. And the reason is, we actually get quite a big pickup in being able to give more gearing by adding this extra credit risk of Barclays. 

But when we look at Barclays as credit risk, and this is senior unsecured Barclays risk, that’s one of the G-SIB banks in the world, which is basically the globally important banks around the world. So they’re seen as almost too big to fail. They have to hold extra capital. 

So, we can offer more gearing by adding Barclays, and we don’t think it adds a lot more risk from that point of view. Who is going to pay you back and when is what you should be asking when you’re buying a structured product. And we believe Investec and Barclays are decent names that you can rely on from that point of view.

The Finance Ghost: And so, in terms of actually practically investing in this thing, Brian, can you just take us through minimum investment amount and how investors actually go about getting access to this product? 

And if I could maybe ask you to just confirm from an EasyEquities perspective (because a lot of listeners are obviously on that platform), is it possible as well? Because I know historically a lot of the Investec products have been available through EasyEquities. It is something that people can do?

Brian McMillan: Yes.So from that point of view you can speak to your advisor, your IFA or your stockbroker. Most advisors and stockbrokers we know in the market, we go and market to them directly.

The closing date is the 10th of July, and we will trade this on the 15th of July. You have to have a stockbroking account, which you fund. You put the money in. It’s R100,000 minimum investment. Although people like EasyEquities will allow you to invest in lower amounts. 

We ask that EasyEquities, for example, give us a minimum of R100,000 and they can split it up however they wish. It is available on that platform, and we have had some talks with them recently to make sure that all the products are on that platform.

But as I said, any stockbroker in South Africa should be able to advise you on this, as will most independent financial advisors out there in the market.

The Finance Ghost: So, Brian, we’ve dealt with what this investment actually is, the sort of risks that investors would be taking, credit risk, liquidity and the minimums and all of that kind of thing.

Last question is of course an important one. People are always quite correctly focused on fees. So, in terms of this product, I know historically from conversations, typically the returns that you’re giving here are net of fees. Same story here, or how should investors be thinking about the fees in this?

Brian McMillan: Same again. And as you mentioned earlier, structured products have changed over the years. One of the things that initially people were sceptical about was hidden fees within it. All the fees and costs have been worked into the product. So, we pay the advisor the fee. 

But your return that we’ve been talking about, the 1.25 geared to a cap of 60%, that would be net of any fees. So, if you buy it at R100,000 and it goes up and you make a 25% return, you’ll get R125,000 back, net of all fees in that.

The Finance Ghost: Perfect, Brian. Thank you so much. We’ll make sure that the show notes have got the link to the right place on the Investec website for potential investors and those who are curious to just go and find out more. 

I can’t stress this enough, please speak to your financial advisor. Do not treat this podcast as me saying, “Oh, this is a great idea” or giving it any kind of green tick. You need to go and obviously look at this for yourself. 

This is really just to help you with your research process. And you can go and listen to some of the previous Ghost Stories featuring members of the Investec Structured Products team if you want to just hear some consistency in how they do things. 

A lot of those products would have closed now, obviously, but you can still go learn some more about how this stuff works. 

Brian, good luck with this raise. Thanks, as always, for bringing it to the Ghost Mail audience. I think it’s as interesting as it always is. Wishing you all the best with a successful raise on this one.

Brian McMillan: Thanks, Ghost. 

This podcast is for informational purposes only and does not constitute advice. You must speak to your independent financial advisor before investing in any product, and especially this one. Investec Corporate and Institutional Banking is a division of Investec Bank Ltd, an authorised financial services provider, a registered credit provider, an authorised over the counter derivatives provider and a member of the JSE. Ts and Cs apply to this product and you should refer to the Investec website for full details.