While concerns about whenever the 'next crisis' will come forcing investors to also look overseas for investment opportunities, South Africa's market continues to develop, with the latest innovation wrapped around the introduction of bank strategy underlyings, particularly with a domestic equity risk premia offering on its way. SRP talks to Ryan Sydow (pictured), head of distribution, structured and risk solutions at Barclays Africa about the market and its operations and participants.
Which structured products are preferred in the South Africa market?
There is a strong demand for offshore underlyings and also for offshore, non-ZAR denominated hard currency trades. With the 'next crisis' seemingly always around the corner, there is strong sentiment and demand to reference other markets or to move money offshore to less volatile climes. Satisfying this demand is not without its issues, given very low interest rates in developed markets and historical equity market returns.
In terms of payoffs and underlying strategies in hard currencies, we see sustained demand for autocallables for those happy with some risk and target vol underlyings for those happy to look long term with a large degree of capital protection, cheap optionality being a must here.
The lack of demand for exposure to domestic underlyings can be attributed to investors realising that the days of 20% pa returns from the local markets are gone and, given they are already long South Africa Inc through domestic unit trusts and stock portfolios, structured solutions referencing non-South Africa underlyings seems to be the tactical play at hand and then advice being given to investors.
Our income and growth split structures with capital protection and some sort of fixed-rate element have seen success. That set up resonates with a wide investor base, because people want protection, a fixed return, gearing and a mix of short and long tenors.
Smart beta underlyings are also gaining traction, and we have first-hand experience using some from the Barclays (Brais) stable and are launching our own South Africa equity risk premia range in conjunction with the Department of Finance at Wits University. One of the more complex solutions was chosen because of its similarity to a balanced fund from the Barclays Multi-Asset Sharpe Risk Control range. This index reflects the performance of a multi-asset allocation strategy which allocates assets in accordance with a quantitative model to deliver returns. The strategy is applied to a set of assets from five different asset classes: equities (including developed and emerging markets equities), commodities (including gold), fixed income, real estate and cash. With the additional complexity, you have to make sure investors and advisors alike understand the risks they are exposed to. There is a fine line with underlyings like this, but they can offer value to more sophisticated investors and the opportunity cost relative to staying in cash is almost zero. To bring those kind of products to the mass affluent market could result in suitability issues.
We are strongly in favour of moving towards products with a low or target volatility filter, or one that combines different factors away from market cap-weighted underlyings, because they could provide a better outcome and risk management experience better suited to long-term investment products. The secondary benefit is that they are, generally, cheaper to write optionality on. We firmly believe in a world where the underlying is constructed in order to minimise the cost of the hedging instrument to deliver and economically useful service, that being the de-risking of a portfolio.
Which are the preferred wrappers?
We don't see demand for structured deposits, given this would be in the mass market, non-advised retail space and the reward is not compelling enough versus the reputational risk of selling these via a very unsophisticated salesforce. The fact that any return would attract income tax is another factor, with the higher tax rate at 41% tax in South Africa. But, if you wrap a structured note within an insurance vehicle, that becomes very tax efficient. We were quite fortunate to have a life company within the group, which we used to wrap vanilla-listed securities. With these products, the tax liability is with the life company as opposed to the end client, who will receive the return net of tax because it is paid from the excess loss of the life company. Even without access to an assessed loss, the life-wrapped vehicle is tax effective and efficient.
We also have vanilla note and listed securities programmes, which provide investments held for longer than three years with returns that attract capital gains tax. It's called Long Equity Investment Plan Security (Leips), which is similar to ESP, a vehicle Investec uses.
What are the relevant regulations and what has been the effect of RDR?
The Retail Distribution Review will not have a particular impact on our structured products. Barclays' retail distribution policy/programme already caters for provisions of RDR, because the bank is in RDR territory already. South Africa's RDR will likely be a close replica of the UK regulation.
The impact of RDR in the domestic structured products market will be limited, although it has much wider implications for short-term insurance.
How large is the average new issue in South Africa?
This varies by issuer and product, but, on average, a public offer will gather around ZAR50m-70m (US$3.7m-$5.2m), although there have been trades as large as ZAR500m. Product issuers that have good in house distribution are at a distinct advantage. I don't believe the independent financial adviser community is using structured products as much as they could be, making IFA-only issuance sizes quite a bit smaller.
Describe the competitive landscape
There are number of players covering different angles. Investec is active with some good products, but do have some complicated multiple foreign exchange pairings in the odd trade. FirstRand looks like it is gearing up to become an active player, in addition to the CPPI offerings it has out of Rand Merchant Bank.
We don't see foreign providers making large inroads. Local issuers that are part of an existing set up dominate and have a leg up on any new entrants. Those companies with access to private banking and wealth management networks have an advantage over others, and that is defining the competitive landscape. However, there is still room for other providers to increase their footprint via partnerships with existing distributors. Another area with potential for growth is financial advisers.
Itransact has been a success as an administrator of structured products, but perhaps struggle to provide an attractive enough proposition to convince distribution to sign up. The most successful platforms, save for perhaps Alan Gray, are part of larger insurance or bank groups and it's difficult for independent platform to compete.
Fund platforms are not that open to structured notes, but we don't have a problem with that as we believe the on-exchange listed platform/stockbroker approach will take over, and we expect a number of brokerage firms to move in, and that is why our focus is on our listed range.
Exchange Control regulations are also a challenge, forcing the listing of products on offshore underlyings on the Johannesburg Stock Exchange, which comes with additional listing costs. The JSE is finally coming round to setting up a fee structure to list structured notes that is reasonable, which can only be a good thing for the industry and for transparency.
The first SRP Africa Structured Products & Alternative Investments conference 2016 will be held at the Hyatt Regency Hotel in Johannesburg between 16-18 November 2016. See link for details.
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