A structured route back into equities

Structured solutions can allow investors to take advantage of high volatility in the market place to generate higher income. Investors looking to get back into equities are certainly more attracted by structured products that provide them with an element of capital protection. But with interest rates at record lows, investors are typically very interested in income too, says Al Plattner, Emea head of sales for retail structured products at Citi. Investors, in other words, are looking to structured products to replace that income they no longer get from other types of products. Rewarding risk Reverse convertibles, which are income-based products, generally allow investors to gain from a non-decrease rather than from the rise of equity markets. In the current environment, they may be considered an interesting solution. Investors buying into these products, depending on the structure, generally risk a part of their capital if the market falls but participate in the upside if the market rises, and, in the current environment of high volatility, will get an annual coupon which is higher than what they would get in conditions of lower volatility. This is because a high volatility is perceived to be indication of a higher level of risk in the market and investors are rewarded for taking that risk. Investors may also be willing to give up some upside in the market, which will mean a higher annual income. What is important is that the investor takes a view on the market. For example, an investor may decide to invest in a structured product linked to an index, which has decreased 40 or 50 per cent, say, during the crisis. If he believes it is unlikely that the index falls by another 40 per cent over the five years of the life of the product, he will be willing to take the risk of losing 40 per cent of his capital in return for the 8 per cent annual coupon; ie he estimates that the chances of making 40 per cent income will be higher than losing 40 per cent of his capital. Jean-Luc Bernardi, Emea head of structuring for retail structured products at Citi notes that investors willing to take a degree of risk on their capital tend to be more conservative compared to the past. “While previously investors might have been willing to be protected against the first 30 per cent fall, they now prefer to be at risk if the market is down 50 per cent over the whole life of the product,” says Mr Bernardi. “In doing that they are taking less risks and in exchange for that they are generating less additional money to be invested in growth or income.” Brimming with features A whole host of features can be built into structured products. For example, they can have an element of look-back to mitigate short-term investment timing risk. This solution will allow the investor to enter the market at an optimal level, rather than the average, over a predetermined number of months, but it will be more expensive. For investors who do not wish to take a view on the market, non-directional plays, trading strategies oriented products, which can take the form of funds or notes, are now very popular, says Mr Plattner. Whether the investment strategy, which can be built on different underlyings, should go long or short depends on quantitative triggers in the market. In these solutions, like in all structured products, there is no element of manager discretion in relation to the return, differently from it happens in hedge funds. Structured products operate under predetermined rules and people like this transparency, says Mr Plattner. There is a whole supermarket shelf full of different products in the market place and investors can reshape whatever exposure to the market they want by picking the product that suits best, says Mr Plattner. But the danger of structured products is mainly in the execution of the marketing material. “The risk for any structured product is that it is misdescribed to an investor or misunderstood by an investor,” he says. “There is a huge incentive for structured product manufacturers to make sure that everything is simple and easy for investors to understand and that, if structured products are complex, people get the appropriate help warnings.”

Jean-Luc Bernardi: Those investors willing to risk capital are more conservative than in the past