KBC Capital-Protected Funds - KBC-Fondsen met kapitaalbescherming
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Dear reader, This brochure has been divided up into three parts, each identified by a different colour. That way, you will not have to read the entire brochure if you are only looking for specific information. The blue part will clarify how a fund offering capital protection works. Among other things, it will explain why the price of such a fund may fluctuate before maturity. In the green part, the various fund types and their specific characteristics will be explained in detail. If, for instance, you are looking for more information on click or Equiplus funds, you will be able to find it here. The orange part, finally, will provide answers to frequently asked questions. Take the time to read it through. Maybe you will find the answers here to your own questions about these funds. We hope that this brochure will help you find your way around the popular world of capital- protected investment funds.
INTRODUCTION Why are capital-protected funds so popular? As a result of efforts by the European monetary Other advantages, besides capital protection? authorities in fighting inflation and the decline in pub- lic deficits, interest rates in Europe have become much Capital-protected funds meet the needs of many lower than they were in, say, the 1980s or 1990s. demanding investors. The return they offer approxi- Investors, who were getting steadily diminishing mates the results that can be achieved in the financial returns on their traditional bonds, started to look for markets they track, without the capital invested being new sources of income or returns. put at risk. In the 1990s, they showed a growing interest in long- In some cases, capital gains may also be locked in term investments in shares. However, the bullish years before maturity, as with the popular “click funds”. were followed by a sharp downturn on the financial markets, particularly in certain sectors of industry, such Capital-protected funds can also offer attractive buy- as telecommunications and technology. in opportunities (through reset or lookback options), or guarantee a certain minimum rate of return (the Capital-protected funds offer investors an attractive ‘Best of’ range). alternative to direct investment, especially investors who still have to learn the ropes. They teach them how Still other funds aim to outperform the underlying to keep track of the financial markets and become stock markets (EquiPlus funds). familiar with the risks – and not just the potential return - associated with shares, without putting their Moreover, investments in capital-protected funds are capital at risk. liquid before maturity, since prices for transactions in these funds are set every two weeks. Since 1993, KBC has systematically launched capital- protected funds and during the more recent, riskier This brochure aims to provide you, the reader, with a years, has even come out with numerous new types of thorough explanation of the main types, features and capital-protected funds. As a matter of fact, KBC is far workings of capital-protected funds. and away the market leader in these funds. KBC Asset Management – a KBC Bank subsidiary - also designs and develops these funds for other financial institu- tions around the globe.
HOW DO CAPITAL-PROTECTED FUNDS WORK? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 First objective: capital protection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 The fund’s fixed-income component How does it work? Interest rates influence the fund’s fixed-income component Second objective: performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 The fund’s option component How does it work? All kinds of factors influence the fund’s option component prior to maturity The workings of capital-protected funds: money flow diagram . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 BASIC TYPES OF CAPITAL-PROTECTED FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Equisafe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Features of the “classic” Equisafe formula The option component Interest rates and volatility influence the participation rate when the formula is designed Ways to increase the participation rate Ways to optimize the starting value Click . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 The ladder formula The “cliquet” formula Ways to increase the cap
CONTENCE EquiPlus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Features of the EquiPlus formula The option component Multisafe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Multisafe Currency X/Currency Y Multisafe Interest FREQUENTLY ASKED QUESTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
HO W DO CAPITAL-PROTECTED FUNDS WORK? Capital-guaranteed funds and/or funds offering a guaranteed return have two investment objectives: 1. To give the investor his starting capital back in full or in part on the final maturity date (before charges). 2. To pay the investor any capital gains made by the fund. There are various kinds of fund offering capital protection. Generally, 100% capital protection is available, but sometimes – in only a very lim- ited number of cases – the rate of protection may be lower (90%, for example). In any case, all the capital-protected funds have a fixed maturi- ty date. The capital gain these funds make will depend on the change in the value of the “underlying” (i.e., a stock market index, shares, interest rates or currencies) on the final maturity and/or on interim maturity dates.
First objective: capital protection The fund’s fixed-income component How does it work? In order to offer capital protection (usually 100%), all The term investments are made at optimal rates of the capital initially invested is put into risk-free, fixed- interest: rates that normally apply for very large, pro- income investments. This is the fund’s fixed-income fessional investors. Every six months, the fund manag- component. er reinvests the capital. Consequently, there is a six- month rate of interest, but it is a floating rate. Howev- er, in order to obtain greater certainty, a fixed interest 100% 100% on the issue price final maturity rate is needed. Consequently, the floating six-month date rate is exchanged for a fixed rate of interest for the fixed-income vastrentend entire term to maturity (generally more than eight component years). This is what is known as an “interest rate swap”. It yields a fixed amount of interest, regardless of changes in the interest rate. The present value of starting date final maturity date this interest amount is determined by discounting future streams of income. This discounted interest Generally, the money is put into six-month time amount is then used to buy options, and these gener- deposits that are subsequently renewed. This risk-free ate the return (i.e., the capital gain) on the final matu- investment ensures that you get 100% of your starting rity date. (See part 2). capital back (before charges) on the final maturity date. Naturally, these time deposits yield interest in the meantime, interest that might come to, say, 30% Interest rates influence over the entire term to maturity. the fund’s fixed-income component A capital-protected fund is therefore, to a large extent, a fixed-income investment. As is the case with interest 30% other fixed-income investments, such as bonds, the 100% 100% on the issue price final maturity value of the fund is sensitive to fluctuations in interest date rates. fixed-income vastrentend component Influence of interest rates when the fund is designed starting date final maturity date If interest rates are high when the fund is set up (e.g., 7%), the interest amount will be high. However, this interest is not paid out to the investor. In this case, there will be more money available for Instead, it is used to generate a capital gain. buying options, and the fund will be able to offer bet-
HOW DO CAPITAL-PROTECTED FUNDS WORK? ter terms as far as the return is concerned. Influence of changes in interest rates On the other hand, if interest rates are low (e.g., prior to the fund’s maturity 4.5%), these terms will be less favourable. The interest rates prevailing on the market when the As an investor, you have to remember that the net fund is set up therefore affect the terms, which the asset value of such funds may on occasion fluctuate fund can offer as far as performance is concerned. considerably prior to maturity. If, for instance, interest rates head up sharply two years after the fund was set up, the value of the underlying fixed-income invest- ment will go down – which is exactly what happens 7% with bonds, too. As a result, the net asset value of the interest 4.5% 100% fund will drop. issue price 100% on the final maturity This, however, is only temporary, since the effect of date any interim loss in value will have disappeared com- fixed-income component pletely by the final maturity date. Consequently, you’ll get your starting capital back, no matter what (before charges). The contrary also holds true, of course. If interest rates starting date final maturity date fall before maturity, the fund’s net asset value will go up. But, again, this will only be temporary: on the final maturity date, the value of the fund will be back at 100%. Market interest rate trend Interest 6.50% Explanation of the graph: rate 1. 1. An increase in interest rates 8-year rate = 5.50% 2. will result in a loss in value of and sudden rise to 6.50% Time 2. axis the fixed-income component 3. but this loss will be only tem- porary Change in valuation of 100% fixed-income component 100% 3. 4. by the final maturity date, 4. the fixed-income component will become less sensitive to changes in interest rates and its Starting Final value will move back up (dot- date maturity ted line) to the 100% mark. date
Second objective: performance The fund’s option component How does it work? Besides protecting your capital, the fund must also The option component is designed by financial institu- yield a return. This is referred to as the fund’s per- tions specialised in complex options and other finan- formance, i.e., the capital gain it achieves. In order to cial derivatives (e.g., KBC Financial Products or another achieve this capital gain, the fund may, for instance, international derivatives broker). Using the interest track the increase in a stock market index. Note, how- income, the fund will buy the options from this coun- ever, that the fund will not actually buy shares in this terparty and thus become entitled to any capital gains index, but share options. That’s why this is called the made. Generally, the fund will buy call options, which fund’s option component . entitle it to buy shares at a fixed price. If the underly- ing shares (or stock market index) go up in value, the call option will also go up in value (= this is the capital 30% gain the fund is seeking to achieve). With the call Interest income options, the fund can buy the shares for less than the 25% discounted price they were quoted at when the options were pur- income Fixed-income chased. options So, the counterparty will sell the options to the fund and get paid out of the periodic interest payments. Starting date Final maturity date The fund will buy these options at the start, using the All kinds of factors influence the fund’s present value of the (expected) interest income. This is option component prior to maturity explained in the above graph. Over the entire term to maturity, the fixed-income component may yield a The value of the options is affected by such factors as return of 30%, for instance. But because the fund buys changes in share prices, the volatility (price fluctua- the option at the start, account has to be taken of the tions) of the shares concerned, and interest rates. present value of the interest income. This comes to just When do these factors have a positive impact on the 25%. This is the discounted or present value of the option component? future stream of income - If the stock market goes up, the call options will be worth more (see the diagram below). - And this will also be the case if the volatility of the shares increases. Higher volatility means agitated markets and strong price fluctuations.
HOW DO CAPITAL-PROTECTED FUNDS WORK? - If interest rates go up, call options will also increase in value. Note, however, that the effect of the options’ increase in value on the fund’s net asset value is offset in part by the fact that the increase in interest rates causes the fixed-income component to go down in value. Diagram: change in the value of the option component if the stock market goes up Discounted, the stream of interest at 30 % is worth 25%; that 25% is invested interest 30% in call options 100% 100% on the issue price final maturity date Fixed-income Assume that the trend on the stock Trend, stock market is as follows: market index first a period of calm followed by a steep climb above the 100 starting value of the index at 100 In this case, the value of the call option would develop like this: Value of the option 25 EUR
The working of capital-protected funds: money flow diagram In a nutshell, the entire mechanism looks like this: Investor Fixed-income Option component 1 component 7 2 3 4 Time deposit Fund Options 6 5 Explanation of the above graph: 1 the investor invests capital in the fund 2 the fund puts the capital into a fixed-income investment 3 this generates interest income for the fund 4 the fund uses this income to buy (usually call) options 5 on the final maturity date, the fund will receive the capital gain realized on the options and 6 100% of the capital from the time deposit account 7 the investor will get his capital back on the final maturity date, along with the capital gain.
BASIC TYPES OF CAPITAL-PROTECTED FUND There are two main groups of capital-protected funds: equity-linked and non-equity-linked. KBC offers three basic types of capital-protected equity-linked funds: • Equisafe • Click (ladder and cliquet formula) • EquiPlus KBC also offers a wide variety of capital-protected non-equity-linked funds under the Multisafe umbrella. The difference between the above types of fund lies mainly in how the option component of these funds is constructed. Provided here is a brief explanation of the basic types of funds, but be advised that there are a number of variants.
Equisafe Features of the “classic” Equisafe formula Equisafe formula • 100% capital protection at maturity Equisafe funds have the simplest structure. In addition • 100% of the increase at maturity to your initial investment, you will receive a certain You get 100% of the increase at maturity percentage of the increase in the value of the underly- 180 ing on the final maturity date. This underlying may be: 170 - a single stock market index or a basket of stock mar- 160 ket indices; 150 - a basket of individual shares; 140 - or some other combination. 130 How much you ultimately receive will only be known 120 on the final maturity date. When the fund is launched, 110 however, how closely the underlying will be tracked 100 will be specified as a percentage (for instance, 100%). 100 % protection This percentage is called the ‘participation rate’. 90 80 Maturity date Example: An Equisafe fund offering 100% capital pro- Positive scenario tection at maturity + 100% of the increase in the Euro- Negative scenario pean stock market index, DJ Euro Stoxx 50. The fund’s performance depends on two variables: - the participation rate, which in this case is 100%; - the underlying stock market index; in this case the DJ There are two points of reference in the Equisafe for- Euro Stoxx 50. mula: the value of the underlying on the starting date If this index goes up by, say, 80% before the fund and its value on the closing date. No account is taken matures (positive scenario), the investor will get a of any increases or decreases in value prior to maturi- gross return on the final maturity date of 80% (the ty. The situation on the final maturity date is what 80% increase is tracked at a rate of 100%). determines the ultimate return. If, by the final maturity date, the value of the DJ Euro Stoxx 50 has fallen below the starting value, then In order to avoid a situation where the final result there will of course be no capital gain, but your capital would be determined by a large, chance fluctuation in will still be 100% protected. value at the start or on the final maturity date, the starting and closing values are generally determined on the basis of the average of a number of reference values. For instance, the starting value is generally arrived at by taking the average of the prices for the first ten
BASIC TYPES OF CAPITAL-PROTECTED FUND Equisafe days following the close of the subscription period, may be lower than 100%. Calm financial markets, on and the closing value is determined by taking the aver- the other hand, have a positive influence on the par- age of the prices for the last ten evaluation days prior ticipation rate. to the maturity date. Ways to increase the participation rate The option component In order to offer an as high as possible participation In an Equisafe fund, an ordinary call option is pur- rate, despite difficult market conditions, some funds chased with a long term to maturity, equal to the term take a creative approach to make options less expen- to maturity of the fund. sive and consequently increase the participation rate. A call option will entitle the fund to buy shares for a fixed price. Asian tail Here, the closing value and/or starting value of the Interest rates and volatility influence the underlying is determined on the basis of the average participation rate when the fund is designed. of prices on various days over a longer period of time. Such periods may run from six to as much as twelve Influence of interest rates months. This technique not only makes the options cheaper, If interest rates are low, the interest income from the but also ensures that the risk of a sudden drop in the fixed-income component will be smaller, and there value of the underlying is mitigated to some extent. If will therefore be little money available to buy options. the starting/closing value is determined on the basis of This will generally mean that there will be a lower par- a single or just a few, consecutive stock market days, ticipation rate. The contrary also holds true, too, of the odds of its being less favourable are greater. course. If interest rates are high, the participation rate may be as high as 130%. Light formula Influence of volatility This technique takes the worst performing shares out of a share basket on an interim maturity date (gener- Volatility is the degree to which share prices fluctuate. ally halfway to the final maturity date). On the final A high degree of volatility means agitated markets maturity date, the best performing shares are also and strong price fluctuations. A high degree of volatil- removed. Based on the remaining shares, the percent- ity also means expensive options. In this case, the inter- age increase in the value of the basket is determined. est income available will not buy many of these expen- sive options. The participation rate, in this case too,
Example of the “Light” formula: KBC Equisafe Telecom Invest X – participation rate 100%. Lookback formula • 100% capital protection on the final maturity date At the outset, the basket contains 21 telecom shares. • The capital gain = the closing value of the basket less the lowest value during the Lookback period if < starting value On the interim evaluation day, the five worst perform- (= 100), divided by the starting value ing shares are removed from the basket. On the final maturity date, the six best performing shares are like- Investment simulation wise removed from the basket. A weighting of 10% is 150 given to each of the ten remaining shares. 140 The investor’s capital gain is 100% of the increase in 130 value of the ten remaining shares. Without this technique, which results in fewer shares 120 determining the final result, it would not have been 110 New possible to offer this sub-fund with a participation rate starting value 100 of 100%. 90 80 Point-capped formula Lookback period Capital gain = (150 - 90)/100 = 60% In this case, the price increase per share is limited, or capped. In other words, to calculate the percentage increase in the value of the basket, the increase in the price of each share will, for instance, be capped at a maximum of 100% on each evaluation day. These eval- uation days occur at the end of the term to maturity. Ways to optimize the starting value Best in or Lookback formula The performance on the final maturity date is deter- The performance of the fund on the final maturity mined by the difference between the starting value date in this case depends on the increase in the value and the closing value of the underlying. There are for- of the share basket relative to the lookback value. This mulas for optimizing (read: lowering) the starting is the lowest value of the underlying index/basket dur- value after the launch of the fund. Formulas like this ing a pre-determined period after the launch of the are expensive, though, which means the participation fund, the so-called lookback period. This is a technique rate offered will be lower. Consequently, they will only for optimizing the starting value. be resorted to if stock market trends are uncertain on the near term.
BASIC TYPES OF CAPITAL-PROTECTED FUND Equisafe Reset formula This formula also makes it possible to improve the starting value. The index will get a new (lower) start- ing value, if it falls by a fixed percentage (the reset level). Conclusion The features of an Equisafe fund can be summarized as follows: • the investor enjoys the benefit of capital protection on the final maturity date (before charges); • the investment result is linked to movements in a stock market index, a basket of stock market indices or a diversified basket of shares; • on the final maturity date, the change – increase or decrease – in the value of the underlying index or bas- ket is measured; • the capital gain the investor receives on the final maturity date is a certain percentage, 90%, for instance, of the increase in the value of the underlying index or basket; • if, on the other hand, the basket has gone down in value, the investor will receive his initial capital back, with no capital gain. ➠ Since the capital gain depends on a single reference point, i.e., the change in value on the final maturity date compared with the starting date, this type of fund is more suitable for the dynamic investor.
Click Some investors find that the final maturity date is too age clicked in, the investor will receive the full far ahead. They also want certainty regarding the cap- increase. This is referred to as a “ladder structure”, ital gains that can be realized before then. The click since each “click” is a “rung” up on the ladder and formula makes it possible for this need to be met. means more profit on the final maturity date. Within the click fund family, there are ladder and cli- quet funds. Example: Ladder formula 10/20/30 up to 60%. A click fund linked to the DJ Euro Stoxx 50 index, based on the 10/20/30 up to 60% formula. Let’s assume the DJ The Ladder formula Euro Stoxx 50 index has a fictitious starting index of 100. Features of the Ladder formula • After two months, the index has gone up to 110: a 10% capital gain is locked in. The underlying index and/or share basket is tracked • In the following months, the index falls to 80, but extremely closely during the entire term to maturity. this does not have any adverse effect on the 10% Once the underlying goes up in value by a certain, pre- locked in. determined percentage, that percentage will be • In a subsequent period, the index jumps up to 130, locked – i.e., “clicked” - in. That means that this gain and an additional 20% gain is locked in (in two stages: will accrue to the investor and be paid out on maturi- at a level of 120 and 130). ty, even if the value of the index/basket subsequently • Even if the DJ Euro Stoxx 50 subsequently nose-dives, falls below the clicked-in level. If the increase on the the investor will still receive a gain of 30% at maturity final maturity date is higher than the highest percent- in addition to his initial investment (see the diagram above). Ladder formula • 100% capital protection at maturity The option component • 100% on the increase in the index on the maturity date • Clicks at 10, 20, 30, 40, 50, and 60%, if reached before maturity 140 Click: 30% A click fund with a ladder formula makes use of ladder 130 call options that lock or “click in” at specific levels. Click: 20% With the above 10/20/30 up to 60% formula, one lad- 120 Click: 10% der call option is bought with ladder “rungs” at 10, 20, 110 30, 40, 50, and 60%. 100 Ladder options are more expensive than ordinary call 90 options with the same term to maturity (see the Equi- 80 safe formula). 100% protection 70 Moreover, the price goes up as more rungs are built into the ladder. This type of structure is thus more like-
BASIC TYPES OF CAPITAL-PROTECTED FUND Click ly to be created when market conditions are Example (explanation of the diagram): favourable (i.e., higher interest rates, low volatility). A fund with a cliquet formula on the Dutch stock mar- ket (AEX index) with a 10% cap. Each year, the level of the index is compared with its The cliquet formula level the preceding year. If it has gone up, the increase will be locked in. If the Features of the “classic” cliquet formula increase exceeds the pre-determined cap of 10%, 10% will be locked in (interim periods 1, 3, and 8). With the cliquet formula, no gains are locked in when If the index has gone down, this will not count, and a certain percentage is attained, rather when certain 0% will be locked in for this interim period (interim dates are reached. These dates – generally one a year – periods 2 and 7). are set when the fund is launched. On the final matu- If the index goes down in value during an interim peri- rity date, the investor will receive the sum of all per- od, the next period will start at a lower index value. centages locked in during the life of the fund. The per- This increases the chance of a better percentage centage that can be locked in each year is usually lim- increase being locked in at the close of the new inter- ited, and this maximum percentage is referred to as a im period. “cap”. Cliquet formula KBC DISTRICLICK • 100% capital protection at maturity • the sum of the “clicks” for each interim period A very popular click fund, KBC Districlick offers dis- • any decline in value does not count tribution shares; i.e., the gains it realizes are paid Clicks per out after the close of each interim period in the interim period 15% form of a coupon. Total 1: +10% The maximum coupon is the cap percentage. Cap: 10% 10% 2: 0% The cap for a Districlick sub-fund will – market con- 3: +10% 5% 4: +4% ditions being equal – be slightly lower than the cap 5: +10% 6: +8% for a “classic” Cliquet fund, since paying out gains 0% 7: 0% on the interim dates is more expensive than paying 1 2 3 4 5 6 7 8 8: +10% +52% gains out on the final maturity date. -5% (5.37% yield to maturity, before -10% charges)
The option component cap will be lower. On the other hand, high interest rates and calm financial markets (with a low degree of For a cliquet fund, a single option is not purchased as volatility) will have a positive influence on the cap. with the Equisafe funds, rather a series of short-term options are purchased, i.e., call spread options. Ways to increase the cap A call spread option is the combination of two ordi- nary call options. In order to be able to offer an attractively high cap, • a call option is purchased with a strike price equal to despite a low level of interest rates (or high degree of the starting value of the index (e.g., 100 at the start of volatility in the market), a broad cliquet structure is each period). sometimes used. Per interim period, any drop in the • and a call option is sold with a strike price equal to value of the underlying index/basket will be deducted, 100 + the cap (e.g., if the cap is 10%, the strike price or in other words, a loss may be locked in for that peri- will be 110%). od. This loss too will be limited – to a so-called floor – The number of call spread options that are concluded which will be kept as low as possible; for instance, -3% will depend on the term to maturity of the fund and a year. However, the investor will still enjoy full capital the number of interim periods. For instance, if a fund protection at maturity. has four interim periods, four options will be pur- chased. Why lock in a loss? Because if there is a limited possibility of a loss being Interest rates and volatility influence the “cap” when the formula is designed. “Broad” cliquet formula • 100% capital protection at maturity • the sum of the clicks for each interim period Influence of interest rates In this case, too, the level of interest rates plays an Clicks per important role when the fund is set up. interim period If the interest income earned throughout the life of 15% Total the fund is limited (given the low level of interest rates Cap: 10% 1: +10 % 10% 2: - 3% at that time), then there will not be much money avail- 3: +10% able to buy options. In this case, the cap for click funds 4: +4% 5% 5: +10% will be somewhat lower (e.g., less than 10% per annu- 6: +8% al interim period). 0% 7: - 3% 1 2 3 4 5 6 7 8 8: +10% Floor: -3% +46% -5% (4.84% Influence of volatility yield to maturity before If volatility is high in the market, options will be -10% charges) expensive. In that case, it will not be possible to buy many options with the interest income either, so the
BASIC TYPES OF CAPITAL-PROTECTED FUND Click incurred, the options will be cheaper, and this will in between a negative 3% and a positive 10%, for turn make it possible to offer a higher cap. This is instance – instead of between 0 and 7 or 8% as is the referred to as a broad cliquet structure, because the case with the ordinary cliquet formula. range within which the return may vary is broader – Variant: Best of cliquet formula Each year, the level of the index is compared with its level the preceding year. The “Best of” formula is a variant of the ordinary cli- If it has gone up, the increase will be locked in. If the quet formula. This not only allows investors to bene- increase exceeds the pre-determined cap of 10%, fit from capital protection on the final maturity date, 10% will be locked in (interim periods 1, 3, and 8). it also gives them In this example, a modest risk of loss is factored in • either a pre-determined minimum return; (broad cliquet). • or the sum of the percentages locked in annually, if If the index drops in a certain year, a maximum of - this is higher. 3% will be locked in (interim periods 2 and 7). In other words, the investor receives the best of two Since the sum of the percentages that have been options, hence the name. locked in annually in this example (46%) exceeds the pre-determined minimum return of 30%, the How does it work? investor will receive a gain of 46% at maturity. With an ordinary cliquet formula, a series of call spread options are purchased, so that the sum of the amounts locked in annually can be paid out on the Best of cliquet formula final maturity date. However, with the “Best of” cli- • 100% capital protection at maturity • minimum rate of return of 30%, for example quet formula, the interest income is not wholly • OR the sum of the clicks (i.e., amounts locked in) for each interim period, if higher invested in call spread options. Some of the interest Clicks per interim period Minimum 30% or income is used to guarantee the minimum return. 15% total This minimum return offered over and above the clicked in: Cap: 10% 10% 1: +10% capital protection comes at a price, of course. Since 2: - 3% there is less money left for buying options, funds like 5% 3: +10% 4: +4% this generally have a cap that is slightly lower. 5: +10% 0% 6: +8% 1 2 3 4 5 6 7 8 7: - 3% Example (explanation of the diagram): Floor: -3% 8: +10% -5% A fund with the Best of cliquet formula tracking the +46% (4.84% DJ EuroStoxx 50, with a 10% cap and a minimum -10% yield to maturity before return of 30%. charges)
Conclusion The features of a Click fund can be summarized as fol- lows: • the investor enjoys the benefit of capital protection on the final maturity date (before charges); • the investment result on the final maturity date is linked to movements in a stock market index, a basket of stock market indices or a diversified basket of shares; • in the interim, the gains are locked – or clicked – in, which means that the gains will accrue definitively to the investor. The fact that gains are locked in before maturity makes this type of fund particularly well suited for the more defensive investor. Advantages of the ladder formula Advantages of the cliquet formula • If the index/basket goes up in value by a certain, • Per interim period – generally once a year – any pre-determined percentage, that percentage will increase in the value of the index/basket will be be locked in. locked in. • Any percentages that are locked in will accrue • If the index goes down in value during an interim definitively to the investor, even if the index/basket period, the next period will start at a lower index subsequently falls below the value that was locked in. value. This increases the chance of a better percentage increase being locked in at the close of the new interim period. • Each percentage locked in (i.e., “click”) is a “rung” • The return on the final maturity date is the sum higher and means a bigger return on the final of the percentages clicked in annually. maturity date.
BASIC TYPES OF CAPITAL-PROTECTED FUND Equiplus EquiPlus Features of the EquiPlus formula KBC EquiPlus Digi-Opportunity X basket of 20 blue-chip shares KBC EquiPlus is different from the Click and Equisafe • 100% capital protection in EUR at maturity • 5 interim periods formulas. The key feature of the click funds is the fact • + 20% per interim period if none of the prices of the shares in the basket < 50% of its starting value that gains are locked in at certain intervals, while the • + 0% per interim period if the price of at least one share < 50% of its starting value. key feature of the Equisafe formula is the participa- Investment simulation based on a basket of five shares tion rate. EquiPlus funds, however, concentrate on 70 Sum of the gains 60 1 2 3 4 5 per interim period “outperformance”, i.e., on yielding a better return 50 than the underlying investments (e.g., a share basket). 40 Periode 1: + 20% 30 Periode 2: + 20% Hence the name, “EquiPlus”. Periode 3: + 0% 20 Periode 4: + 20% 10 Periode 5: + 20% 0 Totaal + 80% The option component -10 -20 -30 -40 The fund seeks to outperform the underlying by using Floor -50 -50% exotic options instead of ordinary options. These -60 -70 options are more complex than ordinary call options. One of the examples of an exotic option is a digital option. Example. KBC EquiPlus Digi-Opportunity X KBC EquiPlus Digi-Opportunity X offers the investor Digi-Opportunity, the most common type of EquiPlus 100% capital protection on the final maturity date fund uses such options. A digital option (referring to (before charges) and a capital gain that is dependent computer digits 0 and 1) is an all-or-nothing option. If on the change in the value of a basket of 20 blue-chip a specific condition is met, the investor will make a tidy shares. profit, if the condition is not met, there will not be any The capital gain will be determined at the close of (or only a very limited) return. each interim period (there are five). It will depend on whether or not one of the following occurs: In the Digi-Opportunity type of fund, one digital If none of the prices of the shares in the basket falls option is purchased per share in the basket. So, if a below 50% of its starting value during the period, a basket contains twenty shares, for example, twenty return of 20% will be locked in for that period. individual options will be purchased. Every day, the If the price of at least one of the shares in the basket prices of the underlying shares are checked to see if falls below 50% of its starting value during the period, they are above a certain level. a gain of 0% will be locked in for that period. In that case, the share that has fallen most from its starting value at the close of the interim period will be removed from the basket. This means that the weakest
share will no longer adversely affect the fund’s per- formance in subsequent interim periods. Conclusion The features of an EquiPlus fund can be summarized as follows: • the investor enjoys the benefit of capital protection on the final maturity date (before charges); • the investment result on the final maturity date is the sum of the gains achieved for each interim period; • these gains will depend on whether or not a certain condition is met during the interim period; • if that condition is met, the investor will make a tidy profit, if it is not, there will not be any (or only a very limited) return. • with formulas such as this, the capital gain realized on the final maturity date may be higher than the increase in the value of the underlying index/basket. Given the typical “all-or-nothing”/”a lot-or-a little” structure of these funds, an EquiPlus fund is more suit- ed for the dynamic investor.
BASIC TYPES OF CAPITAL-PROTECTED FUND Multisafe Multisafe KBC regularly comes out with capital-protected funds Multisafe Currency X/Currency Y whose performance is not dependent on shares, but • 100% capital protection at maturity rather on other financial instruments. Most of these • 1 EUR = or > 1 USD: 7% • 1 EUR < 1 USD: 0% funds are marketed under the name Multisafe. The possibilities and variants on this type of fund are 1,05 Relevant 1,04 percentage: legion. 1,03 1: + 7% 2: + 0% 1,02 3: + 7% The most common formulas are those based on the 1,01 4: + 7% Total + 21% exchange rate between two currencies (Multisafe cur- 1,00 0,99 (4.88% yield to rency X/currency Y) and formulas whose performance maturity, before 0,98 charges) depends on the interest rate trend (Multisafe Interest). 0,97 1 2 3 4 Multisafe Currency X/Currency Y Example. KBC Multisafe USD/EUR X Besides preserving - on the final maturity date - the Features value of the initial amount invested (before charges), this fund seeks to achieve a gain. which depends on With this type of fund, the investment result is the movements in the exchange rate of the euro (EUR) dependent on the currency market. Based on move- relative to the US dollar (USD) during each interim ments in the exchange rate between two currencies, a period. certain percentage gain will be locked in per interim If the EUR/USD exchange rate is higher than or equal period. The sum of the gains for all interim periods will to 1 USD at the close of an interim period, a gain of 7% be paid out on the final maturity date by way of will accrue to the investor on the final maturity date, return. regardless of the actual exchange rate trend during this interim period. If, however, the EUR/USD exchange The option component rate is lower than 1 USD at the close of the interim period, no gain will be locked in. Digital options are also used for the Multisafe curren- cy formulas. A digital option is an all-or-nothing op- Conclusion tion. If a specific condition is met, the investor will make a tidy profit, if the condition is not met, there The features of a Multisafe Currency X/Currency Y will not be any (or only a very limited) return. As a fund can be summarized as follows: result, the exchange rate is checked periodically to see • the investor enjoys the benefit of capital protection whether the condition has been met. If so, a certain on the final maturity date (before charges); return will accrue to the investor, otherwise, there will • the investment result is dependent on movements in be no return. the exchange rate between two currencies;
besides his initial investment, the investor will receive the option (the fund) to make sure it earns a minimum the sum of the gains locked in per interim period on amount of interest, thereby assuring this product’s the final maturity date; “Best of” feature. • these gains will depend on whether or not a certain The second option enables the investor to benefit condition has been met during the interim period; from a higher return if the underlying interest rate if the condition is not met, no gain will be locked in. goes up. Via a simple call option on the underlying interest rate, 100% of the increase in that rate can be Given the typical all-or-nothing structure of these offered. Sometimes the participation rate is lower funds, a Multisafe Currency X/Currency Y fund is better (90%, for instance), depending on the market condi- suited for the dynamic investor. tions that prevail when this product is designed. Example. KBC Multisafe Interest X Multisafe Interest The investment result on the final maturity date is dependent on movements in the ten-year EUR (swap) Features rate. When the fund is launched, a floor of 6.25% is fixed. This floor is locked in as the minimum gain that With a Multisafe Interest fund, the result is dependent will accrue to the investor. on the interest rate market. For instance, it may be Each year, at the start of each interim period, a certain dependent on movements in the ten-year euro swap return is locked in, i.e., the best of either 6.25% or the rate (an interest rate used by financial institutions in ten-year euro swap rate in effect at that time. their dealings with one another). This formula com- bines the technique of locking in gains annually with Multisafe Interest X the “Best of” formula. • Per interim period, the underlying interest At the outset, a minimum percentage or floor is set. • Minimum rate of return for each interim period: e.g., 6.25% Each year, at the start of each interim period, a gain is “locked in”. This may be either the floor or the ten- 12% Relevant 11% percentage: year euro swap rate for that moment, whichever is 10% 1: + 7.00% higher. 9% 2: + 6.25% 8% 3: + 10.00% 7% 4: + 7.00% 5: + 6.25% The option component 6% 6: + 6.25% 5% 7: + 6.25% 4% 8: + 8.00% 9: + 9.00% The return offered by a Multisafe Interest fund comes 3% 10: + 12.00% 2% from a floor option and a call option on interest rates. 1% Totaal + 78.00% (5.93% yield to In other words, two options are purchased! A floor 0% maturity, before 1 2 3 4 5 6 7 8 9 10 charges) option is an option designed to limit the risk of a downtrend in interest rates. This enables the buyer of
BASIC TYPES OF CAPITAL-PROTECTED FUND Multisafe If this interest rate is lower than the pre-determined floor of 6.25%, the floor will still be locked in; in other words, the investor is sure to receive a return of at least 6.25%. The result on the final maturity date will be the sum of all gains locked in for all the interim periods. Conclusion The features of a Multisafe Interest fund can be sum- marized as follows: • the investor enjoys the benefit of capital protection on the final maturity date (before charges); • the investment result is dependent on the interest rate trend; • the return the investor receives on the final maturity date is the sum of the percentages locked in per inter- im period; • the return locked in per interim period will be either the pre-determined minimum rate of return or the interest rate prevailing at that time (whichever is high- er); the investor will therefore always get the better of the two. • thanks to the minimum rate of return, the investor is protected in case interest rates fall; • if interest rates go up, the investor can benefit from this, too. This formula with a pre-determined minimum rate of return makes Multisafe Interest particularly suitable for the highly defensive investor.
FREQUENTLY ASKED QUESTIONS
1 Where can I find information on the net 3 Do I get the same guarantees regarding asset value of a fund? capital protection and minimum returns if I buy into the fund after the fixed subscription The net asset value of all capital-protected funds is cal- period? culated twice a month: on the first banking day follow- ing the 16th of the month and on the first banking day Yes, you get exactly the same guarantees. following the last day of the month (the days on which But bear in mind: the capital protection only applies to it is calculated are specified in the prospectus). This net the starting value of the fund during the subscription asset value is published in the Financieel Economische period. If that starting value is 1,000 EUR, for instance, Tijd, in L’Echo, in certain other newspapers and on Tele- and you buy into the fund later on at a price of text. It is also available on the following Web sites - 1,200 EUR, then only the 1,000 EUR is guaranteed. In www.kbc.be and www.kbcam.be - along with a dia- other words, you will be risking 200 EUR. gram, product information, and the prospectus. If a minimum rate of return is set for a fund as well, then, on the final maturity date, you will receive the minimum rate of return calculated relative to the 2 Do I have to keep units in the fund until starting value during the subscription period and not the final maturity date or can I sell them relative to the amount you paid if you bought into the before then? fund after the subscription period. You do not have to keep your units in the fund until the final maturity date. Units or shares in these funds 4 What charges will I have to pay if I sell are actively traded at fair prices, which are accurately before maturity? calculated based on the components of the fund (valu- ation of the fixed-income component and the option If you sell before the fund’s final maturity date, an exit component). Any sales of shares before the final matu- fee of 1% will generally be charged. Lower charges rity date are settled at the next net asset value. (0.5% instead of 1%) may apply on sales of shares in Orders placed between the 1st and the 15th of the certain sub-funds during fixed periods. The exact month will be settled at the net asset value calculated terms and conditions will be set out in the prospectus on the 17th (or the next banking day). available in your bank branch and on the Internet at Orders placed between the 17th and the next to the (www.kbc.be or www.kbcam.be). The amount of these last banking day of the month will be settled at the charges is used to unwind the construction (partially), net asset value calculated on the 1st (or the first bank- so that the remaining investors in the fund are not ing day) of the following month. adversely affected. N.B.: the guarantees regarding the capital protection When growth (i.e., “capitalization”) shares are sold, and rates of return are only valid on the final maturity you will also – besides the exit fee – have to pay 0.5% date. in stock market tax (max. 375 EUR) (e.g., for KBC Equi-
FREQUENTLY ASKED QUESTIONS safe, KBC Click, KBC EquiPlus). other party buys the shares that make up the stock On the fund’s final maturity date, too, you will have to market index. pay this stock market tax. Most markets/exchanges* are sufficiently liquid so When income (i.e., “distribution”) shares are sold, no that purchases of this magnitude will not affect pricing stock market tax will be due (e.g., KBC Districlick). on those exchanges (in other words, there will be no marked increase in the index following such purchas- es). Actually, shares must be sufficiently liquid before 5. What factors determine the net asset value they can be included in a specific market index. for secondary pricing purposes (valuation of With share baskets, only a small percentage of the cap- the fund prior to maturity)? ital invested is put into any one share. The various par- ties to the contract ensure that all the shares in the The value of a capital-protected fund prior to its matu- basket are sufficiently liquid. rity date may fluctuate and may be affected by all kinds of external factors. The option component is val- *On smaller markets, this could be a problem; as a ued prior to maturity at the effective value of the result, they are not often chosen as the underlying for option. Factors such as the price trend of underlying a click fund. shares, market volatility, the residual life of the option, etc., all play a part in this. The value of the fixed-income component is greatly 7 How can I be sure that I am getting a fair influenced prior to maturity by interest rate fluctua- price? Could the financial parties not be tions. However, the influence of interest rates will manipulating prices? have disappeared completely by the final maturity date. (See also p. 8). When a capital-protected fund is designed, KBC Asset Management will ask for prices from various profes- sional counterparties. These are major, reliable finan- 6 Do banks with their click funds cial institutions (so-called investment banks). Of the (sometimes involving large sums of money) prices offered, the best are of course selected, which is have any impact on the pricing of the in the investor’s interests. By allowing competition underlying stock markets/shares? free rein amongst the various counterparties, KBC Asset Management can get the best terms for its Click funds are launched on underlying markets investors. The net asset value prior to maturity is also (exchanges) that are sufficiently liquid. A click fund is calculated objectively on the basis of market prices. able to offer the terms set out in the prospectus by Every 16th and last day of the month, KBC Asset Man- entering into contracts with a number of other parties. agement will ask for prices from all the counterparties With click funds that track a stock market index (the DJ with which it has entered into contracts on behalf of EuroStoxx50 for the EMU/S&P500 for the US, etc.), the the funds. The counterparties will quote both a buying
and a selling price. Since the counterparties do not 9 The underlying index/share basket has know whether KBC Asset Management plans to buy or gone up in value, but this is not reflected in sell when they quote their prices, they will be objec- the net asset value of the fund; on the tive. These market prices are used, after being contrary, the net asset value has actually checked, to determine the funds’ net asset value. One gone down. Why is this? way these prices are checked is by comparing them with prices calculated by KBC Asset Management The net asset value of a capital-protected fund does itself, since KBC Asset Management has sophisticated not depend solely on changes in the value of the mathematical models at its disposal that enable it to underlying index/share basket. Other factors also play come up with a price that is in line with the market. a part, the interest rate trend in particular is very Consequently, pricing is transparent. important. In order to ensure that capital protection can be pro- vided, the sum invested is put into a fixed-income 8 Who bears the risk of capital protection as investment (= the fixed-income component). such? Interest income from this fixed-income investment is not paid out but is used rather to buy options (= the KBC, as the counterparty for capital-guaranteed funds, option component). provides a moral capital guarantee. By bearing the The fixed-income component reacts just like a bond to risks associated with the funds itself, KBC is required to any increase in interest rates prior to the maturity develop a whole system of controls to keep these risks date. It will go down in value, and this will have a neg- to a minimum. The main risk for investors is in fact the ative effect on the net asset value. risk they take in respect of KBC Bank – a bank with a Consequently, it is entirely possible for the underlying high credit rating (AA3 from Standard & Poor’s) – and index/share basket to go up, while the fund’s net asset not the risk run in respect of the underlying fund. value goes down, owing to an increase in interest rates Moreover, the structure of these capital-protected (see p. 8). products is such that the capital guarantee does not entail a major risk, since the fund’s portfolio consists primarily of risk-free time deposits. Only the interest 10 Why are the gains that are locked in on those deposits is invested in so-called swaps (see before maturity not reflected in the net asset p. 10). The capital on the time deposits itself is not value? Will I get the amounts locked in if I touched. In this way, there are always enough liquid exit the fund before the final maturity date? assets in portfolio to provide the protection offered. The Belgian Banking and Finance Commission (BFC) Gains locked in are not always immediately reflected supervises everything closely and requires that such in net asset values calculated prior to the maturity funds provide capital protection of at least 90%. date. There are three main reasons for this: • the capital protection: in order to make sure the
FREQUENTLY ASKED QUESTIONS nominal capital can be returned to the investor at you receive the sum of the amounts locked in, in addi- maturity, the bulk of the amount invested is put into tion to your starting capital. fixed-income investments. This component is conse- quently sensitive to fluctuations in interest rates on the financial market. When funds are valued before 11 A low level of interest rates when the the maturity date, the fixed-income component might product is developed means less attractive be worth less on account of an increase in interest terms being offered. Why is this? What can rates. This decline in value may (partially) offset any be done about it? capital gain realized on an interim valuation of the fund. If interest rates are low, there will be less interest • the options: in order to ensure an increase in the income available to generate significant capital gains value of the underlying by the maturity date, options (participation rate, cap, etc.) via the option compo- are used. These will reflect the increase in the value of nent. the underlying perfectly on the final maturity date, Under these conditions, two features may be adjusted: but if this is several years in the future, the value of the • Interest income may be increased: the simplest way options will only reflect movements in the value of the to do this is to lengthen the term to maturity so that underlying to a limited extent. the interest income goes up. • the present versus the future value: what will be • The option component may be made cheaper: there worth 100 EUR on the final maturity date, will not of are a number of ways to lower the cost of the option course be worth that seven years earlier. Because of component, such as an Asian tail, or the light, point- the interest income that has still to be earned, 85 EUR, capped or broad cliquet formulas. for instance, might be worth 100 EUR in seven years’ These formulas were explained in detail on p. 17 and time. 22. Before the final maturity date, these factors may sometimes result in rather unexpected net asset val- 12. What happens to the dividends generated ues. Regardless of whether a capital gain has been by the underlying basket of shares? locked in or not, these three factors may prevent it from being reflected in the net asset value. Still, the The investor will not receive any dividends from shares net asset value always reflects what the individual in the basket. The dividend income goes to the other components of the fund are worth at that point in party that set up the option structure. If this were not time (before maturity). the case, the structure would be more expensive, since If you sell the fund before maturity, you will accord- the other party would miss out on this dividend ingly receive the net asset value in effect at that time; income and would have to compensate for this by this does not include the amounts that have already some other means. been locked in. Only on the final maturity date will
13 How come some funds can offer a With cliquet funds, the increase in the value of the minimum rate of return and others cannot? underlying is seldom fully paid out or locked in. This would make the options far too expensive. By setting Whether or not a fund can offer a minimum rate of a cap, the option becomes considerably cheaper, since return is decided when the fund is designed. In order the cap limits the periodic price increases. to achieve a minimum rate of return, part of the inter- When the fund is designed, the cap percentage is of est income from the fixed-income component has to course determined by the conditions prevailing on the be used. This of course affects the terms the fund market at that time. If interest rates are high and offers (participation rate, cap, etc.). Since there is less volatility in the market is low, a higher cap can be money left for buying options, funds like this general- offered than if interest rates were low and volatility ly have a slightly lower participation rate or cap. Still, high. these funds meet a real need of many – more defen- That is why identical products (with the same term to sively oriented – investors. maturity, the same underlying index, the same curren- cy, etc.), which are launched at different times, may have a different cap. 14 Why do capital-protected funds generally have a long term to maturity (more than eight years)? 16. What about the exchange risk associated with the underlying shares (e.g., US shares)? With a long term to maturity, the capital is invested for a longer period of time and there is more interest When equity-linked funds (those linked to a basket of income. Consequently, more money is available for the US shares, for instance) are designed, KBC may decide option component, making it possible to offer more to accept the exchange risk associated with the under- attractive conditions than if the term to maturity were lying shares. In that case, the effective return will be shorter. paid out in USD on the final maturity date, which With funds offering a minimum rate of return, there is means the investor will be taking a USD risk. an additional reason. If the term to maturity of the Generally, however, KBC will opt for formulas that pay fund is longer than eight years, the capital gain will be out any increase in value on the final maturity date, exempt from withholding tax. without offsetting the exchange rate effect. In this case, the exchange risk will be hedged; the investor will not incur any currency risk. In formulas KBC 15 Why is the full rise in value not locked in designs for (highly) defensive investors, for instance, with cliquet funds; in other words, why is exchange risks are generally excluded. there a cap and how is the cap percentage Whether or not the exchange risk associated with the set? underlying shares influences the fund’s performance on the final maturity date is always expressly stated in
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