Equity Structured Business Retail area RBS VC BRIC Index
What is an index? An index is a tool for measuring the performance of a collection of financial assets. It may, for example, be composed of shares in companies from a specific industry sector or a particular country or it may contain a range of commodities such as oil, gold or wheat. An index is therefore often useful as a benchmark which can be used to represent the performance of a particular market sector. For example, the FTSE 100 Index is a measure of the share price performance of the largest 100 companies that are based in the UK and listed on the London Stock Exchange. In order to determine which shares the index will measure, it uses a set of predefined rules. By utilising a clearly defined, rules-based measure of the market sector (e.g. in the case of the FTSE 100 Index, UK shares), financial institutions, such as banks, can create products linked to the performance of these indices. Why use an index? Diversification Investing in a wide range of financial assets, such as a collection of UK shares rather than just one individual UK share, reduces exposure to the specific risks associated with a particular company. Instead, exposure is to the performance of the market sector generally. A more diverse exposure to the market sector can help create more consistent returns over the medium to long-term. Exposure to new market sectors or investment themes An index can provide exposure to market sectors or investment themes that may otherwise be too expensive or difficult to access. Simplicity An index will use clearly defined rules to help determine which financial assets to track and when. Low cost Gaining exposure to entire market sectors or investment themes without having to buy each individual constituent of an index can save significant transaction costs. The Royal Bank of Scotland plc ( RBS plc ) has created its own range of custom indices which use rules-based techniques similar to traditional benchmark indices, yet aim to offer exposure to specific market sectors or investment themes that you may otherwise be unable to access. The RBS VC BRIC Index is one such custom index. 2
Introducing the RBS VC BRIC Index The RBS VC BRIC Index is one of a range of exclusive rules-based indices created by RBS plc and designed to provide access to a variety of investment themes. The RBS VC BRIC Index The RBS Volatility Controlled ( VC ) BRIC Index (the Index ) is designed to provide exposure to the performance of the shares of some of the largest companies in Brazil, Russia, India and China ( BRIC ). Official Index name The official name of the Index is the RBS VC BRIC Index (EUR) ER 16%. The significance of the terms used in the Index name will be explained in this guide. Additionally, the RBS VC BRIC Index applies two automatic features; a Volatility Control Overlay and a Circuit Breaker. Both features aim to protect the Index against some of the inherent volatility exhibited by shares, and particularly emerging market shares. 3
What are the BRIC countries? The term BRIC is an acronym that stands for Brazil, Russia, India and China. These four countries represent the largest economies in what are typically known as the emerging markets. Emerging markets are those countries that are typically characterised as being under a rapid growth stage of their social, political and economic development. They are generally compared to the developed markets, such as the UK and the US, which often have more mature, well developed economies. With expanding consumer populations, increasingly well educated workforces and higher growth rates than many developed market economies, the growth potential for the BRIC economies, and the companies that operate within them, may be strong. Brazil Brazil is the world s seventh largest economy 1 and is becoming increasingly highly developed with large, advanced agricultural, mining, manufacturing and service sectors. Russia Russia is the world s 11th largest economy 1 and is dominated by its enormous natural resources such as natural gas, oil, and industrial metals such as steel and primary aluminium. BRIC Map India India is the world s 10th largest economy 1. The Indian economy is diverse, encompassing agriculture, a wide range of modern industries, and a multitude of services. India has become a major exporter of information technology services and software workers 2. China China is one of the world s fastest growing economies and became the largest exporter in the world in 2010 1. China is currently the world s second largest economy 1 after the United States, having surpassed Japan. n BRIC countries Brazil, Russia, India and China 1 Source: International Monetary Fund, World Economic Outlook, September 2011. 2 Source: CIA World Factbook, December 2011. 4
Investing in the BRICs Emerging market shares, including those based in the BRIC countries, tend to fluctuate more dramatically than the shares of companies in more developed markets such as the UK and the US. The graph below compares the performance of a traditional benchmark index for the BRIC countries, the DaxGlobal BRIC TR (EUR) Index, with the FTSE 100 Index over the last five years. It demonstrates that although the shares of companies based in the BRIC countries can offer a greater potential for positive returns, they can also suffer from larger falls. This is predominantly because exposure to emerging markets involves certain risks not typically associated with investing in developed market economies. Such risks include economic, social and political instability which may contribute to persistent high uncertainty (or volatility) and/or crashes in the shares of companies based in these regions. An investment in BRIC company shares may therefore potentially be more risky than an investment in developed market shares. The RBS VC BRIC Index is designed to capture the positive performance whilst also aiming to reduce some of the inherent risks involved in an investment in the BRIC countries by reducing exposure to the underlying company shares in times of high volatility. Emerging versus developed market shares Index levels re-based at 100 (as at 1 December 2006) 180 160 140 120 100 80 60 40 1 Dec 2006 1 Dec 2007 1 Dec 2008 1 Dec 2009 1 Dec 2010 1 Dec 2011 DAXGlobal BRIC TR (EUR) Index FTSE 100 Index Source: Bloomberg, 1 December 2011. Please note: This information refers to past performance, which should not be used as an indicator of future performance. 5
The RBS VC BRIC Index The RBS VC BRIC Index is based on the DaxGlobal BRIC TR (EUR) Index (the Core Index ). The Core Index is used to provide the exposure to the underlying company shares based in the BRIC countries. The RBS VC BRIC Index then applies two features to the Core Index as described on page 7. The Core Index is linked to the performance of 40 of the largest and most liquid (readily available to buy and sell) shares of companies operating in Brazil, Russia, India and China with 10 companies representing each country. Each country can have a maximum weighting of 35% in the Core Index while each individual company share can have a maximum weighting of 10% within the Core Index. These weightings are determined by each company s individual market capitalisation. Market capitalisation is a measure of the size of a particular company and is calculated by multiplying the number of shares in that company by the current share price. By limiting the exposure to any one country or any one company, this ensures that the Core Index is broadly representative of the BRIC economies. The weighting of each country and/or each company within the Core Index will change as the prices of the underlying company shares change. As a result, twice a year the Core Index will re-set the weightings to the countries and companies back to the original limits, this is known as re-weighting. The Core Index, and the RBS VC BRIC Index, are calculated in Euros. How are the companies in the DaxGlobal BRIC TR (EUR) Index weighted? Each country has a maximum weighting of 35%. Each company has a maximum weighting of 10%. Each company within each country is weighted by its market capitalisation. To be eligible for inclusion in the Core Index, each company must be incorporated and/or headquartered in Brazil, Russia, India or China. Top 10 companies within the Index Company Country Weighting in the Index China Mobile Ltd China 10.12% China Construction Bank Corp China 9.22% Gazprom OAO Russia 8.51% Petroleo Brasileiro S.A. Brazil 6.17% CNOOC Ltd China 4.72% Vale S.A. Brazil 4.72% NK Rosneft OAO Russia 4.65% Reliance Inds Industries Ltd India 3.09% Companhia de Bebidas Brazil 2.91% das Americas Lukoil OAO Russia 2.86% Source: Thomson Reuters, 1 December 2011 Country weighting within the Index n China 36.28% n Russia 27.51% n Brazil 23.87% n India 12.34% Source: Thomson Reuters, 1 December 2011. 6
Volatility Control Overlay On a short term basis, markets can behave unexpectedly and this is particularly true of emerging market shares which can experience large movements in their price. Volatility is one measure of these price movements and is the amount by which the price level of a financial asset moves from its average price over a set period of time. As such, volatility is often used to describe the uncertainty in share price movements and so is often used as a measure of risk. Historical trends have shown that generally, volatility and performance have an inverse relationship: market rises tend to be steady (i.e. with low volatility) while market falls tend to be short and sharp (i.e. with high volatility). The RBS VC BRIC Index has an automatic feature known as the Volatility Control Overlay that aims to provide some protection against volatility. Application of Volatility Control Overlay Exposure to the Core Index 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 0% 15% 30% 45% How does the Volatility Control Overlay work? To determine how volatile the Core Index is, the RBS VC BRIC Index compares the daily level of the Core Index to its average level over the last 20 trading days. The amount of movement from this average level gives a specific volatility level. If the volatility of the Core Index on a particular day is at or above a pre-determined level (in this case 16%), the RBS VC BRIC Index will proportionally reduce exposure to the Core Index, down to a minimum exposure of 0%. In this case, the Index will not be exposed to the Core Index and so the Index will not grow in value. If the volatility of the Core Index on a particular day is below the pre-determined level, the RBS VC BRIC Index will increase exposure to the Core Index, up to a maximum exposure of 100% of the performance of the Core Index. 60% 75% 90% 105% 120% Daily Volatility By reducing the exposure to the Core Index during periods of higher volatility and increasing exposure to the Core Index during periods of lower volatility, when markets are more stable, the RBS VC BRIC Index seeks to make the most of market rises and reduce exposure to market falls. Obviously though, if markets rise in a volatile manner then the Volatility Control Overlay may limit the effect of this rise on the Index. The Volatility Control Overlay is based on the historical relationship between volatility and performance and this relationship may not continue in the future. Circuit Breaker As emerging market shares can be significantly more volatile than developed market shares, the RBS VC BRIC Index has a second feature called a Circuit Breaker that aims to provide a degree of protection against crashes in the Core Index. When there is a sudden spike in volatility combined with a downward movement in the Core Index, the Circuit Breaker is triggered and the exposure to the Core Index will be 0% for five days. During this time the Index will not be exposed to the Core Index and so the Index will not grow in value. 7
What has this meant for performance? The below graph demonstrates the performance of the Core Index as well as the impact on the performance of the RBS VC BRIC Index of controlling exposure to the Core Index through the Volatility Control Overlay. Simulated and historical performance of the Index Index levels re-based at 100 (as at 1 December 2006) 180 160 140 120 100 80 60 40 1 Dec 2006 1 Dec 2007 1 Dec 2008 1 Dec 2009 1 Dec 2010 1 Dec 2011 DAXGlobal BRIC TR (EUR) Index FTSE 100 Index RBS VC BRIC Index Please note: This information refers to simulated past performance and actual past performance, neither of which should be used as an indicator of future performance. The performance shown in the graph opposite is net of all costs, adjustments and fees. Actual performance of the RBS VC BRIC Index started on 9 October 2010. The Royal Bank of Scotland plc has retrospectively calculated the Index levels based on the Index rules and historical data from sources the Index sponsor deems reliable. Source: Bloomberg, 1 December 2011. 8
Treatment of dividends The RBS VC BRIC Index will reinvest any dividends paid by the constituent companies in the Core Index. These dividend payments will be reflected in the level of the Index. It is important to note, however, that the RBS VC BRIC Index applies a dividend adjustment on the performance of the Core Index. It does this by deducting, on a daily basis, a rate equal to the prevailing European interest rates plus a maximum of 1% per year from the level of the Core Index. The dividend adjustment represents the cost incurred by RBS plc to gain exposure to the Core Index. Prospective investors should understand that the dividend adjustment will have a material effect on the level of the Index. Such adjustments are not passed on to investors as a fee but will be deducted from the level of the Core Index. If actual dividends paid by the underlying company shares comprising the Core Index are greater than the dividend adjustment then this may have a positive effect on the performance of the Index. If actual dividends paid are less than the dividend adjustment then this may have a negative effect on the performance of the Index. Calculating the Index The Index is the exclusive property of The Royal Bank of Scotland plc. Future Value Consultants Limited ( FVC ) maintains and calculates the level of the Index. FVC shall have no liability for any errors or omissions in calculating the Index. 9
Important considerations Key considerations You cannot invest in the RBS VC BRIC Index directly but can gain exposure to the Index through products that are linked to the performance of the Index. If such products are issued by RBS plc, you could lose some or all of your investment if RBS plc defaults or goes bankrupt. Any product linked to the RBS VC BRIC Index will have its own risks. You will need to read all the relevant documentation and obtain financial advice before investing. The Index is exposed to equity markets and investments in products relating to equity markets may be negatively affected by global economic, financial and political developments. The Index is exposed to emerging markets. Investing in emerging markets involves certain risks and special considerations not typically associated with investing in other more established economies or securities markets. Such considerations include, but are not limited to: higher volatility and less liquidity in securities markets, political and economic uncertainty, different accounting and reporting standards and a higher degree of government involvement in the economy. Further considerations The Index does not invest directly in the underlying company shares that make up the Core Index. This means that you have no rights to these underlying company shares or any associated dividends. RBS plc and/or FVC have discretion in making certain decisions, calculations and corrections which may apply retrospectively or from the relevant date forward, for example, following the occurrence of market disruption events or index adjustment events. The exercise of this discretion may adversely affect the performance of the Index, though RBS plc and/or FVC must always act in good faith when making any decisions, calculations or corrections. RBS plc is a multi-service financial institution, and occasions can arise where RBS plc, any of its respective affiliates or subsidiaries or their respective directors, officers, employees, representatives delegates or agents may have some form of conflict of interest in relation to the structure and operation of the Index. RBS plc maintains a Conflicts of Interest policy as required by the Financial Services Authority to manage any such conflict. The Index rules may be amended by RBS plc and/or FVC acting in a commercially reasonable manner. Any such amendment may be made without the consent of, or notice to, investors in products linked to the Index and may have an adverse effect on the level of the Index, though RBS plc and/or FVC must always act in good faith when making any amendments. The level of the Index may be postponed or terminated if the Core Index is not published, or where, for example, the relevant stock exchanges fail to open or suspend or stop trading. The level of the Index may not be published or, in the event that it is not possible or practicable to continue, the Index may be terminated by RBS plc. Should the Index cease to exist, any product linked to this Index may be restructured or may terminate early. This may have a negative impact on the return on any investment in such a product. The Index operates on the basis of pre-determined rules set by RBS plc. No assurance can be given that the rules and therefore the Index will be successful, generate positive returns or perform better than any benchmark or other indices. 10
The RBS VC BRIC Index is one of an exclusive range of indices that are created, owned and maintained by RBS plc 11
This document is issued and approved by The Royal Bank of Scotland plc ( RBS ) for the purposes of Section 21 of the Financial Services and Markets Act 2000 ( FSMA ). This document has been prepared by RBS and for the purposes of Directive 2004/39/EC, as amended, has not been prepared in accordance with the legal and regulatory requirements to promote the independence of research. Regulatory restrictions on RBS dealing in any financial instruments mentioned at any time before this marketing communication is distributed to you do not apply. This document has been prepared for information purposes only. It shall not be construed as, and does not form part of an offer, nor invitation to offer, nor a solicitation or recommendation to enter into any transaction or an offer to sell or a solicitation to buy any security or other financial instrument. No representation, warranty or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information contained herein and RBS and each of its affiliates disclaim all liability for any use you or any other party may make of the contents of this document. The contents of this document are subject to change without notice and RBS does not accept any obligation to any recipient to update or correct any such information. Views expressed herein are not intended to be and should not be viewed as advice or as a recommendation. RBS makes no representation and gives no advice in respect of any tax, legal or accounting matters in any applicable jurisdiction. This document is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. 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RBS shall have no liability to any person for the quality, accuracy, or completeness of such information or for any delays, omissions or interruptions in delivery of any information relating to the Index. The Index Sponsor is under no obligation to advise any person of any error in the Index (but may do so in its sole and absolute discretion). References to the underlying assets are included only to describe the underlying assets upon which the Index is based. The Index is not in any way sponsored, endorsed or promoted by the sponsor of the underlying assets. The Index Sponsor shall have no liability to any person in respect of any determination, amendment, modification, adjustment or termination in respect of the Index. The Index Sponsor makes no warranty or representation, express or implied in connection with the Index or the purposes for which it is used, and shall have no liability for any losses or expenses incurred in connection with the Index or any instrument linked to the Index. The Royal Bank of Scotland plc is not responsible for the level or performance of the Index. The Index represents a notional strategy investment and no actual investment in the Index components is made. The Royal Bank of Scotland plc is an authorised agent of The Royal Bank of Scotland N.V. in certain jurisdictions. 2011 The Royal Bank of Scotland plc. All rights reserved. The DAISY Device logo, RBS, BUILDING TOMORROW and THE ROYAL BANK OF SCOTLAND are trade marks of The Royal Bank of Scotland Group plc. This communication is for the use of intended recipients only and the contents may not be reproduced, redistributed, or copied in whole or in part for any purpose without The Royal Bank of Scotland plc s prior express consent. Investment products linked to the RBS VC BRIC Index ( Products ) are neither sponsored nor promoted, distributed or in any other manner supported by Deutsche Börse AG (the Licensor ). The Licensor does not give any explicit or implicit warranty or representation, neither regarding the results deriving from the use of the DAXglobal BRIC Index ( Core Index ) and/or related Core Index trademark nor regarding the Core Index value at a certain point in time or on a certain date nor in any other respect. The Core Index is calculated and published by the Licensor. Nevertheless, as far as admissible under statutory law the Licensor will not be liable vis-à-vis third parties, including investors, to point out potential errors in the Core Index. Moreover, there is no obligation for the Licensor vis-à-vis third parties, including investors, to point out potential errors in the Core Index. Neither the publication of the Core Index by the Licensor nor the granting of a license regarding the Core Index as well as the related Core Index trademarks for the utilisation in connection with the Products or other securities or financial products, which derived from the Index, represents a recommendation by the Licensor for a capital investment or contains in any manner a warranty or opinion by the Licensor with respect to the attractiveness on an investment in the Products. In its capacity as sole owner of all rights to the Core Index and the related Core Index trademarks the Licensor has solely licensed to The Royal Bank of Scotland plc the utilisation of the Core Index and the related Core Index trademarks as well as any reference to the Core Index and the related Core Index trademarks in connection with the Products. To find out more about the RBS VC BRIC Index call +44 (0) 800 121 6286