Despite their recent notoriety among local investors, accumulators, a form of structured product, are still popular and useful instruments, especially in a period of market volatility. By learning how to use them and understand the alternatives, investors can make them a useful tool for improving their portfolio returns.
While many warnings and features have highlighted their risk, little analysis has been devoted to deconstructing them in a meaningful way. Few bankers have presented safer, more sensible alternatives to investors who seek to make a similar kind of trade. But if you must take a risk, then do so with full knowledge of what an accumulator truly represents.
Accumulators have four major disadvantages. Liquidity is non-existent because investors can't sell their contracts. Fees and pricing are not transparent as additional fees may be built into the contract premium. Complexity is unavoidable as accumulators take a convoluted route in what should be a simple tactical trade. Protection for the investor is non-existent.
Strip away all the features of accumulators and you will find that you accomplish the same trading plan by selling uncovered or covered puts and earning a premium. Buying an accumulator is the same as selling an uncovered put, but worse, because at least with an uncovered put you can close out your position with one trade. The accumulator's 'knockout' clause limits upside returns. 'Double down' clauses require the investor to buy disproportionately more stock at regular intervals in a devastating, open-ended commitment through the entire term of the instrument.
Selling a put is a contract that commits you to buying a security or asset from the buyer of the put at a set strike price. However, when you sell an uncovered put your losses are determined by the amount of shares and the difference between the strike price and prevailing price of the stock you have committed to buy. While losses can be unlimited when stock prices are rapidly falling, they are limited once you close the position. Selling a covered put adds a level of safety through a hedging.
Unlike accumulators, you can buy and sell puts in the market. Furthermore, the commissions on selling puts are easier to see and probably cheaper than the 1 per cent to 5 per cent fees and the padded premiums charged on structuring accumulators. Puts are also easier to understand and potential losses can be readily limited.
Robert Jones of FCL Advisory says that, 'accumulators are unnecessarily complex and expose buyers to unlimited losses while completely capping their upside returns'.