Structured products have survived many different market cycles

One of the main aspects highlighted across quarters is the robustness of the balance sheets of the main manufacturers and the lessons learnt from the global financial crisis. Another is the regulatory environment which has addressed the ‘hit and run’ culture. It has also left little room for losses related to compensation and redress for mis-selling with new disclosure requirements at the point of sale to the target market, and stringent internal controls for product manufacturers.

“After Lehman, the regulation has become tighter which has helped strengthen the regime we are in,” says Keith Chan, head of cross-asset listed distribution for global markets, Asia Pacific at Société Générale. “For example, more risk disclosures for products and standardisation of documentations that issuers need to follow.

“Specifically, for our warrants and callable bull/bear contract products that have been in the Hong Kong market for a long time now. It has become a mature instrument. Retail investors don’t trade these products if they don’t understand them, and issuers continues their effort to educate, communicating the message ‘you have to understand this instrument before you trade’.”

We are committed to making sure that bid/ask is offered at a fair spread - Keith Chan, Société Générale

In the listed market there are also reputational issues which can impact some players when the market becomes volatile, and the bid/ask spread can be affected and gets wider from time to time reflecting the underlying’s volatility and liquidity.

“We know that, and we take it very seriously,” adds Chan. “As a quality market maker, we are committed to making sure that bid/ask is offered at a fair spread to investors, even at times of high volatility.”

Education

Significant effort has also been channelled into investor education - they are better informed when it comes to investing in structured products – not just about the pros, but also about the potential risks and downsides, according to Rohit Jaisingh, head of capital markets products, DBS Private Bank (Singapore).

“For example, they’re now aware of and have ease of access to information on the risks of writing put options in order to receive a higher coupon,” he says. “If the price of the underlying goes below the put strike, they know they are looking at a scenario where the initial investment is at risk.”

One distinctive feature of a structured product is its flexibility - Rohit Jaisingh, DBS Private Bank

The 2007/2008 global financial crisis may have cast structured products in poor light, but if would be unfair to paint the entire asset class with a broad brush as it all boils down to having a sound investment thesis, as well as robust product design and risk management.

“A well-designed structured product that provides downside protection can help to limit damage, in contrast to the likes of other cash securities which don’t offer such protection,” he says. “In addition, one distinctive feature of a structured product is its flexibility – regardless of the market environment, structured products can be created in a manner that still benefits investors.”

DBS Private Bank itself has launched several market-direction neutral / outperformance structures over the last few years that were designed to address its clients’ needs, based on specific market conditions.

“To date, even with the market and most asset classes being largely in the red, these structures stand resilient and continue to deliver strong positive returns for our clients,” says Jaisingh.

Protection

Capital protection remains a focal point of the value of structured products at times of market dislocation and makes them one of the safest investments out there.

“It is extremely valuable, and it is only one of the many features of structured products that, if applied correctly, can help investors navigate a turbulent market like the current one,” says Long Lee, chief executive and head of financial products for Asia at Vontobel.

Investors who saw protection as an expensive commodity when markets were rallying may think twice after the recent market events. 

Some saw downside deals as expensive and that is the reason why some investors are not using this kind of tools in their portfolios, according to Ferran Llavina, head of structured product desk and flow desk – MoraBanc (Andorra).

“With this crash, [investors] can learn that it’s useful to have in your portfolio hedge deals to manage this kind of storm better,” he says. “As a private bank, before talking about lower entry, higher coupons, and wider buffers, first we have to see and analyse the best way to amend the current portfolios and use all the tools available in the market to restructure these portfolios. Structured products as an asset class can provide new investing opportunities but also can help amend and recover positions in the same asset class or others.”

We see more demand for capital-protected products linked to indices, hybrid underlying’s, gold and funding type trades - Gidon Kessel, Citi Private Bank

The flexibility of structured products is also one of the added value features of these products as investors can also benefit from different market situations. “Flexibility is the key,” says Lee. “For example, investors seeking a similar coupon yield as before may receive a larger downside buffer or a shorter maturity.”

In South Korea, Citi Private Bank has seen some clients seeking to be opportunistic and capitalise on the lower entry levels, with increased buffers and higher coupons for stepdown auto-calls, according to Gidon Kessel, head of the wealth management product division of Korea. “But at the same time we see more demand for capital-protected products linked to indices, hybrid underlying’s, gold and funding type trades,” he says.

Long also points to an increased request on bearish products as a hedging strategy.

“Due to the surge in implied volatility and lack of longer term visibility products with one- to three-months tenor are currently in greater demand,” says Long. “Gold-linked structures also have their fans in this low rate era.”

Opportunities

Llavina sees the current environment as an opportunity to deploy its most recent Recovery product which aims at using structured products to recover positions on a portfolio. “We think this provides a great and conservative opportunity to play with different payoffs on indices (equity, credit, commodities….),” he says.

In the US market, intermediary firm Incapital has seen a big uptick in its custom-based trades, according to Deryk Rhodes (pictured), managing director and head of market-linked products trading and origination.

“Investors are looking to take advantage of selling some of the spike we’ve seen in equity volatility as is the case with our buffered notes for example,” says Rhodes. “That's the beauty with market-linked products - whether the market is going down, up or sideways, there’s always something that can be structured to take advantage of that environment.”

In Singapore, DBS Private Bank also reacted to counter the natural loss of confidence in the market from investors with attractive entry opportunities.

“We took advantage of these prevailing market conditions to offer structured products with a look-back option, which enabled clients to access an entry point or strike level at the lowest level of the underlying over the first month of the transaction,” says Jaisingh. “In some of these products, the market is currently higher by up to 25% from the lowest level. In addition, clients were also able to take advantage of the spike in implied volatilities to book profits on some of the outperformance call warrants and dispersion warrants they had purchased, which had recorded strong performances.”

Two recent examples of how investors can benefit from the recent volatility came from the UK market where Tempo Structured Products announced last week that two of their most recent product suite automatically benefited from improved product terms, “made possible because of recent stock market volatility”.

The UK firm reported that the potential return of the Tempo Long Kick-Out Plan (Option 3) increased from 13.1% pa, to 20.4% pa (an additional 7.3% pa) whereas the potential return of the Tempo Long Growth Accelerator Plan (Option 2) increased from 107.5% to 175% at year five (an additional 67.5%), and from a maximum of 180% to 300% at year 10 (an additional 120%).

“These terms are clearly exceptional, highlighting the unique selling point of structured products generally,” says Chris Taylor, global head at Tempo.

The UK firm introduced a pledge at the end of 2019 designed to give the opportunity to pass on the benefit of stock market movement and other factors which could result in improved terms for investors during an offer period to investors.

“Investors in these plans invested happily based on the terms stated in the brochures, which were already good, but they are now finding out that the final terms have been improved and are even better, Taylor says.’’

Going forward

Although it’s difficult to make a call on market direction at this juncture there is some light at the end of the tunnel. “We can expect uncertainty to persist in the short- to mid-term, until the pandemic comes under control and life returns to some kind of normalcy,” says Jaisingh.

“That said, we maintain a positive outlook on financial markets. Governments worldwide are acutely aware of the enormity of the situation and share a collective will to mitigate and resolve it, including using monetary tools. To provide an idea of how so – during the financial crisis, QE amounted to US$1.75 billion; on contrast, over US$6 billion has been pumped into the market over the last month alone.”

 Rhodes sounds a positive note as he continues to be very optimistic on the growth of the market despite the current uncertainty.

“These products have now survived a number of different market cycles and have adapted with the market and continue to bring value that cannot be easily duplicated elsewhere,” he concludes. “The industry is also a little bit more mature than it was even five years ago.”