Structured products specialist boutique Investment Design & Distribution (IDAD) has made its first foray into the UK retail market with the launch of the Dual Index Defensive Autocall September 2017, a defensive knockout product linked to a basket of indices (FTSE 100 and Eurostoxx 50) hedged by Commerzbank which is being offered via platforms, and outside the traditional plan management set up most issuers use in the UK market to sell structured products.
As the firm considered its options in the UK market it was surprised to see that the plan manager set up had not evolved as expected.
"Perhaps because the market is smaller than it used to be and providers keep rolling over the same kind of products, there has not been much activity beyond the plan manager framework," says Clive Moore, chief executive, IDAD. "We saw an opportunity in the market and we decided to enter the retail segment, and build a comprehensive public offering with a different perspective."
Targeting platforms users
Most of UK investors and advisers use platforms such as Transact, Nucleus, AJ Bell, etc. but the plan management model of opening a separate stock broker account and then buying a medium term note or a preference share "seemed a bit of a waste of time and effort", according to Moore.
"Our approach is different as we offer the raw factory gate asset (security) that can save the end investor 1.5 to 2% in terms of fees," says Moore. "This approach is also preferred by platforms because if you are running a nominee custody platform you'd rather be buying the asset (security) as opposed to entering into another agreement with another custodian/nominee that holds the plan. That's the key to the offer as by having significant lower cost you'll be able to offer better terms."
David Stuff, chief executive at Cube Investing, one of the first advocates of selling structured products outside the plan structure via Meteor Asset Management's Omnium Account, points that there is no reason for a structured note to be wrapped as a plan as it adds an unnecessary administration layer.
"Most advisers have access and use platforms, and most platforms can buy and hold listed notes," says Stuff, noting that this is a very sensible way of buying structured products as without the administration/custody layer the product would have lower fees and that can be passed on to the end investor who will get better terms.
According to Stuff, before RDR plans were popular because they allowed advisers to be paid commissions and after the RDR many expected that unbundled notes would become more popular. The reason why this approach has not taken off is that immediately after the RDR came out the FCA became stricter about the target market and there was a perception that the plan manager had a certain level of control over the investors who bought the product, says Stuff.
"Within this context some of the key issuers thought that by using a plan manager as an intermediary who would buy from the bank and sell to the end investor, that responsibility to know who was buying the product was to some extent shifted one level down to the plan manager who was able to say to the issuers that they knew their target market," he says. "At the same time, platforms were unable (and still are unable) to give any information to the product manufacturer about this."
Efficient distribution
"We believe end-investors would benefit from this approach but it is true that there seems to be a lack of understanding around the mechanics of how the offering works," says Moore. "Most of the products in the UK continue to be sold as plans, and few providers seem to be thinking outside the box to deliver investment benefits to investors in the most suitable way."
According to Moore, most financial advisors now use modern-day platforms and by eliminating these extra layers of cost can make the products more appealing to them and their clients. "There is people in the market (Cube Investing) that have been advocating for this approach for some time now and have been ahead of the market in spotting new opportunities and bringing innovation to improve the market by being early adopters," says Moore.
Stuff has been advocating for this model for years because of the number of benefits. "This approach strips away costs and eliminates plan manager risk - more plan managers have gone bust over the years than issuers, improves liquidity - plans have weekly and by-weekly liquidity windows, takes away the cost of trading the product in the secondary market which can be expensive, and you allow the product to be reported alongside other client's assets," says Stuff.
IDAD went for a low key launch but the firm "wants to innovate and deliver better value to end investors", according to Moore. "The way this product has been adopted by a number of platforms and the sales show that we can deliver what most advisers are looking for," he says.
Value of structured products
IDAD remains committed to structured products and believes it can grow its business in the UK retail structured products market "despite the lower market activity over the past few years", according to Moore.
"We have the lowest historic interest rates and returns from low risk investments are suffering so we are somehow amazed the structured products market is not doing better," says Moore. "In the international market there is a focus on pension and retirement investments and structured products have grown significantly because they deliver. We think this also applies to the UK market and we want to be a player that promotes the benefits of these products. We expect the UK market to provide good basis for growth as interest rates are set to remain at historic low levels for another few years and investors will need to look at smarter ways to get returns."
According to Moore, the UK structured products market caters mainly for conservative investors and "so you have to move investors into new products slowly".
When you get between 30 and 50% of a portfolio into one or two structured products you will be a bit more cautious than if you were putting 5% of a large portfolio into one product, according to Moore. "Fixed income products are delivering 4-5% per year and structured products can deliver between 6 and 9% so we think investors and advisers can see what structured products can offer," he says. "Equity markets have also been pretty benign over the last few years and it seems they will remain like that until the end of the year. However, at some point there will be a correction and more volatility, and structured products also address that market risk. People have also realised that their exposure to corporate bonds have ran its course and there's hardly any value there."
According to Moore, IDAD's main premise is not to link to the particular markets it chooses because "we think they are going to rise strongly but because we think they are less likely to breach the defensive barriers and will be the ones that will perform less badly at times of market disruption".
"From a counterparty perspective we work on the assumption that a product will make up around 20% of an investor's portfolio, and we will always look for an appropriate credit risk so we look for investment grade, decent ratios and CDS, and a suitable market story," says Moore. "We are not going to tie ourselves to a particular issuer. We are looking at competitive pricing and are working with other issuers including investment banks that have been out of the UK for some time and some new issuers as well."
If IDAD's approach succeeds the UK market could be up for a revival of the debate around platform distribution as "there is no reason for products to be sold via an execution only one-deal account (a plan) which is a very inefficient way of doing things", according to Stuff.
"We were disappointed that this format was not more successful but this product shows that there are firms out there considering alternatives and there is scope for this to be a success," says Stuff. "The IDAD /Commerz deal shows that the investment bank is comfortable to say that the product is simple enough to be sold to advised retail clients, and that they will get the minimum investment that they need from the platforms. Mifid 2 now requires all manufacturers to take responsibility for delivering suitable products to their target market and is going to be interesting to see whether platforms and fund managers are going to have very broad definitions of their target market. This set up can solve the problem."
According to Moore, IDAD is effectively a manufacturer and takes on the responsibility and the production of suitable marketing material etc.
"[The] only difference is [that] we're not bundling the custody/nominee service," says Moore.
Prior to its launch in the UK retail market IDAD sold nine private banking structures and four products aimed at international investors in the offshore market.
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