Sales of structured products have soared this year. Société Générale, for example, traded three times the amount of structured products in January and February compared with the same period last year. At this stage of the market cycle, structured products are perfectly positioned for allaying the cautious investor’s fear of capital loss on the one hand, and the more aggressive investor’s desire for gearing on the other, at a time when decent returns are hard to come by.
One factor in the revival is renewed appetite for equity based investments. Before the crisis, equities were the most common underlying in structured products, representing 60-70 per cent of all launches, but according to Nicolas Cagi-Nicolau, global head of structured products solutions at Société Générale Private Banking, equities represented only 5-10 per cent of launches in the last quarter of 2008. Now investors are coming back to equities, and are happy to use products such as capital protected notes to limit their downside risk in this market, with the result that equity underlyings have again risen to account for 50-60 per cent of launches.
Providers are devising structures specifically to entice investors back into equity markets, such as market timer products that optimise the entry point, using the most beneficial position in the first three to six months in the calculation for the maturity payment. These suit investors worried about the markets near term.
But with no interest rate rises in sight and a paucity of growth outside of emerging markets, products are being developed to extrapolate above inflation returns across a variety of asset classes. Developments in the fixed income space include the popular floored floaters with a variable coupon, typically over five years. Providers are getting round low interest rates by structuring funds with longer maturity or with partial rather than total protection. Constant proportion portfolio insurance (CPPI) products still work in a low interest rate environment as they are open-ended, and they are increasingly used for risky assets such as natural resources and sustainability.
Meanwhile the widespread unease around counterparty risk post-Lehman and the very specific scepticism about the transparency and liquidity of structured products are both beginning to wane. “Where clients are suspicious of structured products, it is not so much around their risk/return characteristics, but more ‘What am I paying for the pleasure of participation?’,” says Rupert Robinson, chief executive at Schroders Private Bank.
“The main attraction of structured products is you can alter the risk profile of the investment and quantify your maximum loss at the outset. We also have clients who like to gear their investments – giving up a dividend stream can provide upside gearing on a commodity or an equity index. These tend to have one-for-one downside participation.”
Perceptions that the market can be susceptible to opaque structures and fat margins are starting to be addressed, with firms highlighting competitive charging as a driver behind growing sales. Morgan Stanley has just launched the second of its FTSE100 Accumulated Income funds, which pays up to 3.2 per cent on a semi-annual basis (6.5 per cent gross redemption yield) as long as the FTSE is in the 3800-7500 region. The fund charges a maximum of 50 basis points per annum, cheap compared with some other structured Oeics, and the fee is not taken out in performance drag but reflected in the terms upfront. Matthew Robinson, executive director at Morgan Stanley, cites low cost as a prime factor in sales of over $40m (E30m) between the first two funds launched.
One issue that still deters some investors is lack of liquidity, particularly those who have experienced gates with hedge funds and been locked into private equity deals. Consequently, there is demand for the highest degree of transparency and simplicity, and products listed and quoted on an exchange, especially in the western Europe private banking market.
It helps that some of the funds have outperformed index trackers, and most actively managed funds, over the longer term. Kleinwort Benson, which launched defined return funds into the wealth management industry back in October 2005, reports that its Gresham US Accelerator Index Fund, launched in November 2007, has been in the first quartile consistently since launch.
Another appealing feature of funds is their eligibility for offshore bonds and funds of funds. Mr Robinson says this has been a key driver for the Morgan Stanley FTSE100 Accumulated Income funds, where a significant portion found its way into offshore bonds.
Aviva Investors has offered a series of Defined Returns Funds since May 2009, which are products linked to the FTSE 100 index. The Defined Returns Fund 3 launched in January 2010 will pay 18.75 per cent at maturity in three years if the index is equal to or above its initial level.
