Contact: Ian Howell, (01962) 847540; email: [email protected]

1 Summary

1.1 Structured products are investment vehicles designed for investors who wish to combine the potential upside of stock market growth with a guarantee that they will get their original investment back. They can also be used to provide some protection against falling markets.

1.2 This report summarises discussions between the County Treasurer and the Panel's independent adviser with representatives of Rathbone Investment Management. It seeks the Panel's views on the next steps.

2 Recommendation

That the Panel consider whether to:

- ask Rathbone Investment Management to prepare a report on structured products including the advantages, disadvantages and options for the Fund

- ask Bramdean Asset Management to prepare a similar report

- ask the County Treasurer to investigate whether in-house management of a structured products portfolio by the County Treasurer, in consultation with the Chairman and independent adviser, would be feasible

- ask the County Treasurer to report to a future meeting of the Panel comparing these options for further consideration.

3 Structured products

3.1 The term `structured products' covers a wide range of investment vehicles primarily designed to protect investors' capital whilst providing some benefit from stock market rises. In their simplest form, the Hampshire Pension Fund could place money, say £10m, into an investment fund which is designed to mature at a future date, say five years. The £10m is divided into two parts. Most of the money (£8m in this example) is invested in a low risk bond, which offers a guaranteed return of, say, 25% over the life of the bond. When the bond matures at the end of the five years, the bond will be worth £10m which will provide the guaranteed return to the Fund of its original investment. The remaining £2m of the original investment of £10m, after deducting the provider's commission, is invested in a more risky area in the expectation of capital gains, such as FTSE 100 options. If the FTSE 100 falls over the five years, the options are worthless and the investor is left with original £10m only. If the FTSE 100 rises, the options will provide a gain on top of the protected capital.

3.2 There are more complex structured products available. Protection from falling markets can be built into the product using `autocalls'. This provides a specified return if, for example, the stock market falls 10% after the first year, or 20% after the second year etc. Only if the market falls by, say, 50% would the original capital be affected. As this protection is underwritten by credit providers, their credit worthiness would need to be assessed as part of the evaluation of the product.

3.3 Hampshire's size would enable providers to create bespoke products. The Fund, with the help of a suitable adviser, could specify its requirements for £20m, say, and ask a selection of managers to price up products for comparison. Providers include major financial institutions such as Merrill Lynch, Citigroup, BNP Paribas, Morgan Stanley, Barclays Capital and JP Morgan.

3.4 Some structured products are tradeable and so a portfolio of structured products may need to be managed.

4 The way forward

4.1 Rathbones' representatives commented that Hampshire's relatively large exposure to equities could be advantageous in rising markets but may need some protection when markets fall. Structured products could provide that protection in a more cost effective way than hedging which can be expensive particularly in adverse market conditions when that protection is really needed.

4.2 Rathbone Investment Management's primary business is to advise wealthy individuals, not large pension funds such as Hampshire. As reported to the Panel in November 2007, the Fund's contact with Rathbones was arranged by the independent adviser. They have been helpful in providing additional insights into investment options but are not currently in a position to manage money for the Fund for regulatory reasons. In any case, a separate appointment of a structured products manager would have to be subject to a formal open procurement process.

4.3 If the Panel wishes to investigate the subject further, however, Rathbones could be asked to produce a written paper on how structured products could be used by the Fund. An option could include the management of a portfolio of structured products in-house by the County Treasurer, in consultation with the Chairman and the independent adviser, using one of the Fund's equity managers to secure the necessary bonds and options. Rathbones' views on whether in-house management would be practical or advisable would be helpful. If a portfolio of structured products has to be actively traded to be most effective, external management may be necessary to secure the appropriate skills and knowledge of the market.

4.4 Structured products could be considered a form of alternative investments. Whilst the Fund's advisers on alternative investments, Bramdean Asset Management, have not yet suggested that the Fund should invest in structured products, they could also be asked to report on their views of the options.

4.5 The County Treasurer could then prepare a further report to the Panel comparing all these options and incorporating the views of the Fund's equity managers and the actuary.

Section 100D - Local Government Act 1972 - background documents

The following documents discuss facts or matters on which this report, or an important part of it, is based and have been relied upon to a material extent in the preparation of this report.

NB: The list excludes:

None.

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