What is a kickout?
Kickouts, also called “autocallables”, are one of the most popular types of structured product in the UK. Although they normally have an investment term of 5-6 years, there is the chance for the product to mature before the scheduled maturity date as long as the performance of the underlying (such as the FTSE 100 index) meets its pre-defined criteria.
Typically, the Kickout product will be able to mature before the scheduled maturity date (this is called being “autocalled” or “kicked out”) if on any of a series of pre-defined future dates, normally annually, the underlying has a closing level equal to or above a pre-set level (this is called the kickout level). This kickout level is often the same as the starting level of the underlying (the initial underlying level) but is sometimes lower, or reduces over time.
If the underlying does not meet the set criteria to be “kicked out”, e.g. perhaps on the ﬁrst anniversary of the product the underlying has fallen in price below the pre-specified kickout level, then no return is paid this year and the product continues to the next year towards the scheduled Maturity Date. However, returns that were missed due to the underlying not meeting the pre-defined criteria to be “kicked out” are paid in the future, should the underlying subsequently meet the criteria to be “kicked out” on a future date. This often means that, if the underlying has traded below the pre-defined kickout level for the majority of the time since the start date (Strike Date) and then subsequently increases in price and on the ﬁnal day of the Product (the final valuation date) has a closing level that is equal to or above the pre-defined kickout level, the investor can get the maximum return from the product even though the underlying has not increased or perhaps has fallen in price over the term of the investment. This makes Kickouts attractive to many investors and a popular absolute return style structured product.
Once a Kickout style product has been “kicked out”, no further returns are available from the product and you can reallocate your money into other opportunities.
Most Kickout products aim to repay your initial money on the maturity date if the product has not been “kicked out” unless the underlying has fallen in price to a set barrier level, such as half of the initial underlying level for example. In this case, your capital is normally reduced by a percentage amount equal to the fall in the closing level of the underlying over the term. In this way, typically you are no worse off than being invested into the underlying directly should the downside barrier be hit (although you may have foregone any dividends paid by the underlying).
Why do people buy them?
One of the main reasons for buying Kickouts is the asymmetry of their returns vs buying the underlying asset directly i.e. if the underlying rises, they return a positive return, if the underlying falls, then a Kickout will typically outperform the underlying, and at worst, perform in line with the underlying (excluding dividends).
Asset managers/IFAs love that they can be called prior to the maturity date, sometimes after just 1 year, earning a positive return even though the underlying index may be flat over that period. They are a credible alternative to absolute return funds.
Kickout products also tend to have lower mark to market sensitivities than the underlying itself. For example, if the underlying is down by 10%, the product may only be down by 5%.
What are the main types?
Kickouts come in many shapes and sizes. Each of their variations affects the likelihood of the return and the size of the potential return they pay if a kickout occurs. There are many variations that are regularly observed in Kickout products, here are a few of the main variations.
First of all, the can vary by the amount of underlying’s that are monitored to see if a kickout event has occurred. The most common have one or two underlying’s where the worst performing underlying is used to determine if a kickout event has occurred. Typically, the more underlying’s that a product has, the greater the products pre-defined potential return. Also, the more volatile the underlying, the greater the potential return. For example, if there are two identical Kickouts with the first with an underlying of the FTSE 100 index and the second with an underlying of the Hang Seng China Enterprise index (ordinarily a more volatile index), then the potential return is likely to be higher in the second Kickout product.
They can also vary by the kickout level that is observed. Some may have a kickout level which remains the same on each kickout observation either at the same level as the starting level of the underlying, or at a lower level. Some have kickout levels that step down after each kickout observation date passes. Others have kickout levels that remain the same for all dates bar the last date, which is often much lower than the previous dates. As a rule of thumb, the lower the kickout levels, the lower the potential return, especially in the earlier observation dates. This does however, tend to increase the likelihood of a kickout event occurring.
Kickouts may also vary by the overall term of the product. Some Kickouts may be very short term (6months – 1 year) and others may be longer term (5-6 years). Ordinarily, the longer the term, the greater the potential pre-defined return.
The final main variation of Kickout products is the capital at risk barrier type. Some products have a capital at risk barrier which is observed every day throughout the term of the product (American barrier type) whereas others only observe the capital at risk barrier on the end of the products term (European barrier type. Normally, products which observed the barrier throughout the products term have a potentially higher defined return. There is a growing trend from IFAs to buy those with barriers only observed at maturity as a trade-off between risk and return, opting for products with perceived lower risk, reducing their potential exposure to market black swan events
How can they bought?
There are two main forms in which Kickout structured products are made available in the UK.
The first is commonly known as a Plan, and the second is a security (which could be a Note, Certificate, Bond for example).
A Plan is a contract between the investor and the product provider to provide a defined investment return which is delivered via a security that the product provider invests in.
A Plan is most widely used by retail intermediaries (IFAs) whereas those in security form seem to be the choice of an institutional investor and other professional investors.
A security cuts this additional layer of documentation (created by Plans) out and gives the investor direct access to the security itself sometimes at the expense of the lengthier more detailed marketing material available for a Plan.
There are some well-known draw backs to a typical structured product Plan. They often provide only limited dealing points (monthly dealing dates) and only allow investors to sell the product during its term after the initial offer period (where investors can buy the Plan) ends. The limited dealing points can impact on the ability to use them in a model portfolio where regular rebalancing events occur, and the ability only to sell the Plan can impact the competitiveness of the sell price provided.
A security (certificate, note or bond), whether listed or over the counter (OTC), normally removes these drawbacks. The benefit are they have much more frequent dealing points (typically intra-day), they also offer the ability to both buy and sell throughout the life of the product making them easier to incorporate within a model portfolio.
Securities do however typically come with shorter initial marketing periods, often only 2 weeks. This does however mean that they do regularly have higher defined returns. For example, a Kickout Plan may have a defined return of 10% per annum, whereas an identical Kickout Product in Security form may have a defined return of 12% per annum. After taking into account for the 3% commission that is usually built into a Kickout Plan, the Securities defined return if often higher.