As the structured products market shifts towards a streamlined approach where pre- and post-transaction functions such as transaction management, document generation and marketing materials related to the issuance of products are being outsourced, fund and service management boutique firms such as Fortem Capital Limited and Delta Capita are tapping the market for new opportunities. SRP spoke to Ryan Rogowski, partner at Fortem Capital, about what smaller firms can offer to providers of structured products and what will be drivers of activity in the discretionary segment.

Investment banks in general and manufacturers of structured products in particular are outsourcing functions to third-party service providers including sales, asset management, fintech, and risk management, according to Rogowski, who points that the ever-changing regulatory environment (i.e. Mifid 2) and corresponding increases in compliance costs have forced banks to continually find ways of improving their overall efficiency.

"Financial boutiques have been launched, made up of individuals/teams that are experts in some of these fields, who also have the contacts in the banks," says Rogowski. "These boutique firms have an edge in the market because they can move a lot quicker... they start after and get there sooner."

According to Rogowski, the term 'off-boarding' has become popular recently "especially if you're not a key bank client - the so called 80/20 rule where firms generate 80% of their revenues from 20% of their clients, and you are not delivering enough P&L for the banks to justify keeping accounts open".

"Having someone at the bank to do all the KYC and AML manually, can be costly," says Rogowski. "That's why small firms are taking advantage of this situation. Small firms can work with 40-50 accounts and provide a bespoke service where larger firms are just not able to."

Fortem Capital is a cross-asset boutique with two main facets: fund management - "we are working on our first launch", and an outsourced solutions boutique. "The real value-added we bring to the table is not only around the relationships we can amalgamate but our capacity in responding to the needs of clients in the current environment," says Rogowski.

The firm's "key objective" is to create, analyse, develop and deliver investment opportunities that provide income solutions or specific growth prospects. "However, given the expertise and experience of the team we also assess and deliver solutions that can minimise/optimise the cost of hedging, and address real problems investors face," says Rogowski. "That's where the innovation is coming to the market. This is not necessarily about variance swaps or dispersion trades or some of the investments hedge funds are doing but about addressing specific challenges that our investors face, for example getting a more efficient fx hedge on their equity investments versus what they are currently getting from their actively managed funds or ETFs."

From a client perspective, Fortem sees inflation as a key factor driving investors' activity. "Delivering well considered solutions that can produce 'inflation plus' whilst also considering pricing anomalies/parameters negatively impacting the cost of structured products, will allow us to bridge the gap between the clients' fundamental views and what derivatives and structured products offer," says Rogowski.

FX is a good example, says Rogowski, adding that if you are a GBP investor and wish to invest internationally whilst hedging currency exposure the cost is very expensive. "At Fortem we have delivered solutions to address that objective in an efficient way that provides enhanced potential performance," he says. "Another topic we discussed and noted was that the dividend yield curve has lifted recently but was on a downward trend until recently. When looking at structured products this impacted the forward - the lower the dividend the higher the forward and the higher the forward value of the index and therefore growth products became more expensive to structure and vice versa."

According to Rogowski, being able to offer solutions to capitalise on variations issues from the pricing side of things paired with investors' views is something "we have had significant experience in and can capitalise on, on behalf of our clients".

The low interest rate environment has forced providers in the discreationary fundmanagers (DFM) and wealth management community to look for alternative solutions and accept soft-protection as long as the risk (knock-in) barrier is at a level that is unlikely to be breached in their view, and that approach leaves some premium for the structurer to provide more upside, according to Rogowski.

"Even in a long-term low volatility environment CARS provide a good alternative to add value to portfolios," he says. "In the DFM space you have to be very precise with what you offer and structured products have to be able to stand on their own two feet and stack up against other investment products such as ETFs, bonds, etc."

Volatility is in attendance and drives activity in the structured products market, and the VIX remains "a very efficient tool" to invest in volatility because of its negative correlation to equity markets, according to Rogowski. "The challenge when investing in volatility, especially if you're going long, is addressing the cost of carrying your position over time," he says. "There have been multiple generations of products that aim to address this issue, in a liquid manner, through the deployment of systematic strategies to reduce carry cost."

According to Rogowski, as investors continue their perpetual search for sustainable income they will typically find inherent short volatility positions in their portfolios via the selling of knock-in puts. "That's why we are observing more defensive structures within clients' portfolios and are recommending reducing downside barriers delivering more defensive structures to the investor community, albeit still at multiples of inflation or treasury yields," says Rogowski, adding that investors and businesses have become more conscious of fees, and look even harder at what they are paying for.

"Because of both the fee compression and regulatory requirements on the IFA market we have also noted for example, a continued shift in assets from IFAs towards DFMs," says Rogowski. "In the fund space, you have the active versus passive debate but if you look at the investment profile, a structured product can allow investors to give up some extreme upside and protect from extreme downside, and providers seek ways to increase the likelihood of a competitive return."

According to Rogowski, investors use structured products to preserve and grow their capital and have a different role in a portfolio than a long-only strategy, for instance. "We recently analysed a number of Japanese equity active funds for a client and found the majority were closet tracker funds, which didn't surprise us given the significant growth in passives," says Rogowski. "Structured products are more similar to passive funds - as you know what you should get from the outset, the performance drivers, risks and objectives are clearly stated and therefore leaving aside what's under the bonnet one has a low-cost investment that does what it says from inception."

Fortem is also working on delivering its Industrial Analytics package including strengthening its stress testing and analytical tools, and will make a number of "exciting announcements" over the next few quarters, says Rogowski.

 

The Fortem Capital team

Ed Senior, former head of Delta 1 and hedging solutions at Catley Lakeman Securities. Senior was also head of Europe, the Middle East and Africa (Emea) complex structuring at Citigroup.

Richard McGuire has held senior positions at Castle Street Capital, Tavistock Europe. He also spent 12 years at Citi trading equity index options.

Chris Dagg was most recently a product developer at Catley Lakeman Securities. Before that he was trader in securitised products at Citi for almost eight years.

Ben Hills is also a former Catley Lakeman Securities associate, and before that an analyst and investment assistant at Investec.

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