Lowes Financial Management Ltd, the investment manager of the Lowes UK Defined Strategy Fund (the “Fund”) monitors multiple counterparty banks to ensure that counterparty
risk is diversified, however the Fund is still exposed to the credit risk of the respective banks where over-the counter (OTC) options and corporate bonds have been
taken into the fund portfolio through the purchasing of structured notes. UCITS regulations governing the running of funds dictate that one such as the
Lowes UK Defined Strategy Fund must follow the following rules:
- In aggregate a UCITS fund may invest no more than 10% of its net assets in instruments issued by the same body.
- When one or more body has each issued between 5% and 10% of the fund’s net assets, the total of all of these holdings must be less than 40%.
- No more than 30% of the fund’s net assets may be backed by a single government bond issue.
Structured products all have counterparties when it comes to credit risk; these are the banks that issue the combination of securities present in a structured note. In the case of a structured investment, the return of investors’ original capital is dependent on the solvency of its counterparty. Therefore, part of the decision to invest in a structured product or note is a decision based on the credit risk of the financial institution evaluated by the investment manager. That is, the risk that it will not be able to meet its obligations.
Most retail investor-focused structured products have only one counterparty, meaning that they are entirely exposed to one institution’s credit risk. A diversified investor’s portfolio will minimise this risk by varying the investments across plans which have different counterparties.
What makes the Lowes UK Defined Strategy Fund different to an individual structured product is that it seeks to limit direct banking exposure by substituting this for UK Government credit risk through gilt-backed swaps. The extra security that comes with having several – often stronger – counterparties, or the Government itself serving as counterparty to the investment typically translates into a lower coupon. It’s the classic risk/reward scenario. In retail investing a visible example of this trade-off recently came from Investec’s Enhanced Kick Out Plan 69; there was a 3% difference between the option wholly based on Investec’s own credit (BBB, according to Fitch) and to one that was otherwise identical but based on UK Government credit (AA, according to Fitch) - 10% to 7% per annum respectively. The Lowes UK Defined Strategy Fund can take advantage of trading directly with banks, and trading using gilt-backed swaps. However, comfortable in the knowledge of credit exposure, the investment manager can introduce elements of credit risk into the Fund, with controlled exposure outlined in the UCITS regulations outlined above.
Whilst investors may not replace their individual structured product exposure with the Fund entirely, it is designed in such a way as to act similarly to an equity-based fund, rather than a structured product. The management of counterparty risk, and other risk factors, is just one benefit investors in the Fund may experience.
If you would like to know more about the Lowes UK Defined Strategy Fund, please visit the Fund website UKDSF.com/Literature for the Key Investor Information Document (“KIID”), Prospectus, and Supplement or call Lowes Financial Management on 0191 281 88 11.
The Lowes UK Defined Strategy Fund is a sub-fund of the Skyline Umbrella Fund ICAV and is regulated by the Central Bank of Ireland. The KIID, Prospectus, and Supplement can be accessed by visiting UKDSF.com/Literature and are only available in English.
Lowes Financial Management Ltd, Fernwood House, Clayton Road, Newcastle upon Tyne, NE2 1TL. Authorised and regulated by the Financial Conduct Authority.