Are structured products back on the table for private clients?

Yuri Bender: Our aim today is to achieve some kind of consensus on structured products investing: are these opportunities suitable for all private clients?  Should they be at the core of their portfolios?  How does their use vary between discretionary and advisory channels?  What is a suitable allocation to particular themes?  How do we select wrappers in underlying investments, and is there a big difference in quality between the products being launched?  After a couple of very tough years, is it fair to say that structured products, within private client portfolios are emerging from the shadows once more?

Nick Coghill: When I view private clients it is very much in two different camps.  There is the discretionary institutional market, which to be frank has been growing for the last several years and was not affected as much as the retail advisory side in 2008.  This strong growth has continued, and institutional managers, funds of funds (FOF) and discretionary asset managers continue to use structured or securitised products for a part of their core asset allocation.  I reckon that in the UK wealth industry probably about 5-7 per cent of assets under management (AUM) is within structured on that side.  The growth in that industry has continued unabated.  It is a very different market in terms of liquidity and how people view the products.

The retail or advisory channels represent a very separate market and that is where we have had to deal with the spectre of Keydata and other sagas that have happened. Clearly that side has been dented by what has happened with Lehman Brothers and other events in the market as well as a changing landscape; with the independent financial advisor (IFA) community diminishing rapidly, who have traditionally been the main portal for delivery of these investments, they have shifted a lot of their investments or assets to the private banks, wealth managers and so on.  As buyers per se, they have definitely been hit.  We do not see as big a flow in that space at all anymore.

James Bevan: In terms of the financially advised client group, how much of the reduction in demand might reflect previous poor experience of products held?  It would certainly be my expectation that a number of people bought the headlines – lots of participation in markets, no downside risk – and ended up being quite disappointed with the return path that they experienced.

Nick Coghill: Clearly when you are buying any product, whether it be a hedge fund or a structured product, you need to know what is under the bonnet.  There are good IFAs and probably poor IFAs with all of these things.  I think that the client experience has been disappointing for some, but not only because the headline rates did not deliver what they were meant to do.  To be fair I think that was mainly due to underlying counterparties going bankrupt or, as we saw with the Lifemark/Keydata thing, what was meant to be under the bonnet was not actually there.

James Bevan: Could I put down a marker for general consideration?  For a number of manufacturers and their related distributors, structured products became a mechanism to take egregious amounts of money from clients without the clients necessarily realising what they were giving up.  The premise that there might be a free lunch in terms of having participation in risk asset returns with no downside risks clearly was never going to happen.  Do you think that one of the things that will have changed is a much more grown-up understanding in the market in general that fees are a really very important determinant of returns, and risk cannot be taken off the table without materially affecting potential return?

Nick Coghill: Part of the retail distribution review (RDR), and the packaged retail investment products (PRIP) legislation coming in as well, is to make sure that clients are aware of what they are paying for what they get.  If you are charging fees of 3 or 5 per cent, clients have to balance that versus a risk/reward profile.  The Financial Services Authority (FSA) has quite rightly been very focused on that in terms of making sure that clients know that, if they are paying for an advised basis or they are actually getting an upfront fee, it has to be worth it and the returns have to be worth it.  I totally agree with that approach, and I think a lot of clients are now much more focused on the returns.

Oliver Gregson: You have this sort of supply and demand dynamic squeeze going on with regard to the structured products.  The demand side in terms of the experience that the investors got from the Lehman crisis and the regulatory issues both driving the supply-side pressures, where the regulatory capital requirements under Basel III of structured products are going to have a much higher risk rating as well as the point of disclosure regulation, are going to make it much harder or more burdensome to do this type of business.  For the vertically integrated institutions like the big banks where they are doing both the manufacturing and the distribution, significant changes will need to be made.

Yuri Bender: But one of those is UBS in Switzerland.  We do not have any representatives from that organisation here, but several years ago we had a summit in Zurich, and the head of wealth management there, Jürg Zeltner, made an apology for excessive and inappropriate selling and incorrect hedging of structured products prior to the financial crisis.  He was saying, ‘I am doing this on behalf of the industry.’  Is that a scenario you recognise?

Oliver Gregson: The industry had to put its hand up, and I think a little bit of humility with what we experience goes quite a long way when you are dealing with an individual, where emotional elements are a much larger part of that relationship.  I hope that a lot of the themes that came out of what we experienced in the crisis will stand us in good stead longer term: simplicity, transparency and liquidity, although liquidity is less of a concern for clients these days.  I do not think these are bad things, particularly when you dealing with individuals, to have at the core of what you are trying to do.

Regarding the regulatory environment, we live in the age of big government now, whether we like it or not, and that is a dynamic that is not going to disappear in the foreseeable future.  I think that one should go over and above the de minimis, albeit often increasing, level of regulation and have a duty of care towards your clients.  That will only enhance the client experience and I think engender a much better scenario for both the client as well as the commercial benefits to the organisation.

Yuri Bender: James, is this duty of care commercially viable in the economic climate we live in?  In one of your previous incarnations you were chief investment officer at Abbey and Santander, and I believe one of the key parts of your job was manufacturing these structured products, coming up with the ideas for them, and we know how famous they were in Spain in the mass-affluent retail market there.   However, with the constraints you had, where your advisors could only spend so long with a client and there were targets of assets that they had to bring in, was there time to sufficiently explain these concepts in the kind of economic environment that we have in UK retail and mass affluent banking?

James Bevan: There is a structural challenge associated with the commercial provision of advice in order to allow empowered decision taking.  This has been highlighted in government sponsored reports, and it is very clear there is a significant gap between what investors as financial market participants are prepared to spend on advice and the actual cost of advice provision.  I think that I could argue from first principles that structured products, correctly configured, reduce the burden in terms of needing to understand what is being purchased, because downside risks can be constrained in a manner that is much more consistent with the reasonable return expectations of investors.

That said, I do think that investing is fundamentally very complicated.  The number of risk factors that impact on returns achieved far exceed what statistical probability would have us believe should be expected.  That is a very tough reality, so anything that was based on projection of normal returns clearly falls apart in what is clearly an environment where those sorts of rules are breached regularly.

Daniel De Fernando: The fact that I come from Spain gives me a good view on the recent Real Madrid v Barcelona games and how they were refereed. Having an impartial referee is critical, as is your point about the regulator.  However, fair play goes beyond the referee, and the players have to exercise it as well.  It is not a question of having a proper referee, but the players helping the referee.  I think that a lot of we have had is players not helping the referee to do their job, both in football and in structured products.  The referee is not the one that plays the game that is played by the players.  If we just lay our hopes on a good referee, it is very difficult if the players do not want to play fairly.  I think it is the responsibility of all of us, collectively, especially because in the financial world clients, advisers, private banks and sellers are at a different level.  Advisers are much better equipped than clients.

I agree with James that structured products may have a role in some clients’ portfolios but I think that we have seen the machines creating the products with no thought of the clients’ needs, and then twisting the needs of the clients to get the products in because of the compensation and incentives mechanisms.  Large clients can usually get the same protection by diversification and allocating risk properly and risk budgeting across their portfolios.  Usually, this is much more efficient way and much more transparent.

I think we have all learnt that liquidity is much more valuable than we tend to think when things are going well. Structured products become very liquid at difficult times, and they are very expensive if you want to get out of them.  Capital protection may be something they bring in, but we have seen many of them that do not have capital protection.  Therefore, I think what we need is more fair play.

Jeremy Beckwith: There is an inherent issue with structured products, in that they are one of these things that, when you sell them, you get all of the profit up front for the most part. That inevitably gives huge incentive to sell aggressively just to generate the profits up front.

Nick Coghill: I would say, again, that I differentiate between the two channels.  For the institutional discretionary there is obviously not the commission levels in that these things are institutional products.  With the advisory, yes that is correct; there is an upfront fee payable and that is where we come down to deciding whether it is appropriate for the retail channels.  I return to the asset allocations, and one thing that I think everybody needs to take away from 2008, and should be at the forefront of thinking, is never put your eggs in one basket.  People who pre-2008 had a habit of chasing nice high double-digit returns and structured and other things would have been on that rollercoaster ride.  However, a client should have a very decent risk management in terms of their asset allocation, and spread their risk across several different asset classes.  Structured may or may not be part of that; it depends on the actual underlying risk desire profile of the individual.  In what we call a sideways market these days, my concern is that again it may not be structured products, but advisors may start chasing other absolute return hedge funds and other types of products that may promise to deliver and may not deliver.  We all have to be very cognisant of that as an industry.

Oliver Gregson: Asset allocation is probably part of a whole other discussion, but it is an important point.  In some respects, what we saw through the credit crisis brought a little bit more reality to what clients were demanding from us as providers in terms of returns – the commensurate amount of risk that they were willing to take.  Before 2007, the dynamic was very much that everyone went chasing massive double-digit returns or asking for double-digit returns and of course not wanting any risk.

James Bevan: But only for a brief period, because, after all, we had been through what at that stage was regarded as being the mother of all bad markets in the dot com burst.  We are in danger of assuming that structured products are an asset class when I only see them as a wrapper for taking exposure to assets that are fundamentally deemed to be desirable for the asset allocation.  There are some assets and strategies which are best taken by a structured wrapper.  Therefore, I do not want to spend too much time apologising for structured products writ large, accepting that egregious fees are always something which cause conflict.

There are other challenges which need to be considered within the field of structured product delivery, and transparency is clearly one.  However, I do think that, for those of us who have ploughed through the inch and a half of issue memoranda which comes with some structured products and the mastery of financial mathematics that is required to understand the tail risks, that is a very big ask.  I would also say that, if one goes back to the global financial crisis, it would be inappropriate to say that we did not have very capable people in all of the big banks believing that they understood the nature of the risks that they were taking and the forms of diversification that they had in place to protect themselves, and that these crises do come and that they do necessarily swipe people very badly.

Oliver Gregson: A lot of clients would they were not aware of just how many variables were going to affect their structured products.  I could not agree more that it is a method of implementing or expressing certain parts of their asset allocation, but they were not fully aware of all the different variables that would affect how that thing moved in the secondary market from credit default swaps (CDS) to vol to swaps and so on and so forth.

Daniel De Fernando: And counterparty risk.  Capital protection was something that was sold as a big capital lever.  We found that in reality there is no capital protection at all.  You can even lose 100%.  Coming to your point, I do not think that they are an asset class per se; I think they are instruments to implement certain investment ideas.

James O’Neill: On the retail market it was sold in a very simplified way.  Explaining all the risks, including perhaps reduction in dividend payments for example, is going to the nth degree to explain how derivatives are actually working.  Therefore, if you are selling to a retail public, which is an audience for a lot of our products, then explaining to that nth degree is a very difficult sell.  It comes back to what you were saying earlier on, Jeremy, about how these products were sold and why they were sold – because of the upfront fees that were being granted.

James Bevan: There are two related issues.  One is that the customer’s expectation of their risk tolerance is necessarily conditioned by their immediate past experience.  So, that at the end of a bull market their alleged preparedness to take risk is a lot more than it would be in a bad market.  That is a fundamental problem in attempting to understand what customers really want.  I think the second issues is that we tend to describe risk in terms of volatility and therefore normal market experience.  We do not tend to tell people what the extreme downside risks are.  Indeed, as an industry we have been criticised for discouraging people from taking a long-term view of pensions planning, for example, and holding too much in cash.  I think that this barometer between risk and safety swings continuously, and it is very difficult to get that right.

In the current climate one might argue that there are two other issues.  If one anticipated that structured products were fundamentally based on the risk-free rate and derivatives pricing, we have a risk-free rate that is almost zero and we have derivatives pricing that is elevated by historical experience.  This is not a propitious macro-environment for structured products.

Nick Coghill: Structured products are not the Holy Grail, and I agree wholeheartedly that you should not do things for chasing headline returns.  In an environment where rates are low and vol may be elevated or low, unless it fundamentally makes sense, is simple and transparent, if you start trying to put in loads of different asset classes to get that nice headline rate, that is fundamentally wrong.  I totally agree with you; if they do not work then they do not work, and you should not do them.  That is a mantra that people have to accept in this world.

James Bevan: There is a subtext which I perhaps disagree with, that people who recommended structured products through the bull years were only incentivised to sell.  I mean a large community of advisors, many of whom put forward Lehman products, were appalled at what happened because they, along with the overwhelming majority of the financial markets community, did not anticipate that the global financial crisis would occur with the scale, ferocity and contagion with which it obviously came to pass.  I do not think that ex post we can sensibly plan for those sorts of extreme events.

Nobody in the financial markets industry wholly anticipated the global financial crisis; the wrecked economies, governments and central banks – the lot.  Therefore, to say that we have to wag a finger and say, ‘You knew all about this and we have managed the process extremely well,’ is completely unrealistic.

Yuri Bender: We have talked about ideas, regulation, manufacturing, and about the way these are distributed and sold to the clients.  Are there any fundamental problems with that whole machine?  Is it healthy and desirable for private clients to have their private banking activity so obviously aligned to investment banking, when some bank bosses see private banking predominantly as a distribution channel for structured products?

Daniel Freedman: We started using structured products in 1995; we started plain vanilla index structured products with deposit accounts and things, and I think that the experience has very much been to do with risk and liquidity and what the clients are looking for in those two areas.  I think that the regulators have a large part to play and blame to take, because with products like the Keydata products that were bandied around from a retail point of view, most of us probably looked under the cover and thought that it was a pile of rubbish.  Those types of products are still pervasive in the retail market and are still being allowed to be sold, whereas I think the type of structured products that maybe the institutional markets are looking at, which have much more plain vanilla, clear and precise delivery mechanisms, have a place in client portfolios.  Where we see things is split very much between the retail and institutional, and if you look at what you are trying to deliver from your client portfolios, structured products may well have a place.  Where we consistently look at different products that are on the market, as a product sold to the retail space generally they are [pathed for?] and sold, and their marketing literature is very misleading.

Philippe Bongrand: Selling structured products is essential for the Swiss banks, and if you look at the P&L and the revenue structure it is also clear that it fulfils the need from the client side.  Of course, different types of institutions have a very different look at this.  You have mentioned that some other banks look at the distribution channels from the investment banking side.  I think that very much depends.  You also have banks such as UBS and Credit Suisse, where the private bank is so important that it is rather the investment banks that are the suppliers to the private banks.

Although we are working in a very profitable industry, the key issue is that there is still a gap between what banks deliver and what clients expect.  There is a gap between these two very simple elements, which are basic service standards such as the number of contact clients.  All the studies say this, but it is worth looking at clients on the product and performance side as well, because you match your product with your client in the end, and what many clients are saying is that when they look at banks they find that they are pretty good at managing their own prosperity as an industry, and they do not understand why the banks are unable to manage their clients’ prosperity.  Clients are saying that when it comes to understanding your risk profile as a bank and your risk profile and so on, they do it very well for themselves so they are asking why they cannot do it for them.

In the end, the whole issue of structured products is all about one very simple thing, which is education, education, education.  It is about education of the relationship manager who has to spend time with clients to really understand these things, and I think that we sometimes neglect that is the last mile and it is probably weak links.  It is also about education of the client and also education of the management to see how structured products fit, and how they should be sold and managed through the whole chain in the business model.

Daniel De Fernando: Can I give an example?  Last week or two weeks ago a client of ours was offered a structured product by a bank on a very high yielding telecom, obviously with no recognition of the dividend that was embedded in the structure of this three-year product, where the client would take any loss beyond 50%.  This is today but it has all the ingredients of the rosiest years.

Oliver Gregson: This is why your analogy of it being the players that play the game is a great, simple analogy.  The referee does not believe that the players are going to listen to him.

So what is going to happen?  We have just heard exactly why he believes they are not going to adhere, so they are going to enforce or oblige a regulatory environment which forces the players to adhere to certain standards.  Their views about the FSA are that structures are very point-in-time dependent and there are limited underlyings.  Whether we agree with that or not, that is basically their view, and as a result they are going to mandate the situation.  Hence the Autorité des marchés financiers (AMF) in France with regard to structures and structured finance being a complete no go for retail.  The FSA guidelines, which I am surprised we have not brought up here in the UK, that 25% or above of investible assets should not be in structured products...

James Bevan: Regulation typically follows the immediate prior disaster. I think that I could argue from first principles that structured products should reasonably play a far bigger role in investor portfolios than is presently the case.  For example, you asked why the average investor wishes to hold assets.  It is against some future liability.  For example, if your future liability is to buy a house, buying a structured product gives you geared participation to house price inflation and seems to me a very prudent product for people whose known liability is to buy a house at some point in the future.  That is far better than buying a very transparent, plain vanilla, multi-asset, equity-biased portfolio whose path of return is going to be materially distant from the return on houses.

Daniel Freedman: But with interest rates down at the level that they are, do those types of products work today?

James Bevan: They work.  If I take what a bank does in issuing shared appreciation mortgages (SAM), it theoretically has a pool of returns that it is receiving on the shared appreciation mortgage that it can wrap up and push back out to people who want to buy the reverse sides of their balance sheet.  For me, that is absolutely natural turf for a structured product.  It is within the gift of the banks to manage their balance sheets effectively, because they have off-sold across the piece, and at the same time meet the needs of a very large range of investors who say, ‘Actually, this is my pot to one day buy a house.’

Daniel De Fernando: Yes, but be very, very careful when the client is solving the balance sheet problem of the bank, because they are not in any of the discussion, and I know who is going to lose on that.  Maybe the idea is good; you buy a structured product to hedge you against house price inflation, which is what you need, but you then have to see which index is used, who calculates the index, what fee is embedded into that, what happens if the client has to buy the house early because there is an unexpected child, and see how they can get out of it, what happens if the issuer of the note has a problem and what happens to the client’s house?  There are so many things around that good idea about which I would be very, very careful.

James Bevan: I am not arguing that this is entirely simple and plain sailing.  However, I am saying that a correctly structured product which directly relates to the known and chosen liability of the investor may be a much more appropriate investment that open equity market exposure.

Daniel De Fernando: But what likelihood do you give to such a transaction of the client even being prepared to understand all the risks and all the components that he is entering with the other counterparties?  I would be very, very careful of those things.

James Bevan: I am saying, as much understanding as they may realistically have of the foibles and vagaries of the equity market.

Yuri Bender: Daniel has said a couple of times that the quality of products being distributed and manufactured at the moment takes him back to 2006, and he is not necessarily too impressed with what he sees.  What do the manufacturers think?

James O’Neill: I agree with you, but I have to look at it in a different light.  I break up the retail market hugely in terms of those products which are sold through branch networks of huge commercial banks.  Let us look at the UK for example; the vast majority of those products are what we call capital-protected products.  So the sort of returns that we are looking for are using cheap options: the digitals, the annual digitals and the binary-type pay-offs because of the environment of very low interest rates.  Therefore, the expected return is not great.

In some circumstances, moving away from the commercial banks and their whole branch network of sales, we go into the boutique and the more advisory on the IFA market as a whole.  Those products remain as they did in 2006, 2007 and 2008.  Not a great deal has changed really, apart from the increased attention spent on counterparty risk.  That is really the only change that has occurred.  Therefore, I make a complete distinction against the retail market.

In addition to the advisory markets through the boutiques, we then move into the grey area, which is the private banking and discretionary management area.  We treat the investors as mature adults; they are intelligent, can make their own decisions, and know the investment risks.  Again, it depends on how we are delivering those products as to what is afforded in terms of protection via deposit or compensation schemes and other protective clauses.  However, as far as I am aware, there is a huge difference in the market now.

Nick Coghill: Massive.  I think that there has been a huge divergence.   They used to run side by side, but I think that, as James said, at the retail end it has kept doing what it used to do, aside from the fact that people have now got the counterparty risk element, and that has been afforded by the crisis.  Where we have seen a bit of divergence is on the private banking and up the food chain, whereby there has been a hell of a lot more education both internally and to the institutional buyers of it; they do a lot more trading, intra-day dealing and bid offers, coming back to what we need to do as providers.  What banks have had to do is up the ante both in term of collateralisation of products, putting them into UCITS wrappers and other things to try and mitigate the credit risk.

However, when we are also dealing with more sophisticated clients, like a private bank or institutional, we do not just say, ‘Here is a product, take it and we will see you in five years’ time.’  It is more that we have to sit there and go through this in terms of what they are looking for; we put our Lego bricks together a lot more.  However, I have noticed over the last two or three years that what we have to provide more of is a lot more scenario analysis and simulations in terms of: ‘If x happens, volatility does this, rates do this and markets do this’ – what is going to happen.  We now launch into those spaces, and my personal view is that we as providers have to think of ourselves as fund managers.  We are going to have to sit there, and what we do for a lot of people is every six months or so we put a report together on how it has performed versus benchmark, ‘Why is the market up 10 per cent and this is only up 4 per cent?’ or ‘Why is this 14 per cent versus 10 per cent?’ and explain it so ultimately if it is an institutional buyer they understand it, or if it is an advised channel for a private bank they can explain it to their banks.  I think that every provider in the market should be doing that now.  We should be accounted for as if we are fund managers because we stand and fall by what we launch.  It comes back to your earlier analogy; we are providers so should we be putting out products that we ourselves do not believe in or would not invest in?  I think that in the holy grail world, the answer is no.

Yuri Bender: Jeremy, you are now with an independent private bank, which used to be part of Commerzbank and Dresdner. James Bevan has told us how structured products can be used in a very positive way when there is a particular scenario where a client needs help.  However, with big German banks it was very different.  Themes of the month were identified at the top and these were the  products advisers were told to sell.  Was that the way it worked for you?

Jeremy Beckwith: That was in Germany. I had to fight quite a few battles when I arrived, and I refused to play any part in that and they left me alone.  I was never actually forced down that route.  My view has always been that I decide if I want a structured product in a client’s portfolio, and if I have a particular view on an asset class or something then I design the structured products and go out to the market and get the best price.  I do not get people offering me structured products now because they know that I will never take them.  I design them rather than the banks.  That way I know that it is our investment ideas that are being pushed through.

Nick Coghill: I think that is a great point, and the unfortunate thing is that it cannot translate to the whole world.  I think where the products are the most successful is literally where we, with our little Lego bricks, sit down with an adviser and professional and they say to us, ‘Here is what we are looking for.  We want exposure to this asset class, geography, this type of risk profile.’  We put it together and the questions we now get asked are a lot more in-depth in terms of, ‘Right, tell me what the cost of the bond or option is.’  You can then put all these components and parts together and give the scenario analysis, so then Jeremy or his equivalents will know exactly what they have – what is under the bonnet.  It is no different from dealing with private banks as clients now.  It is a very rigorous process to the extent we use them.  I think that it is right.

Oliver Gregson: However, an extension of that is certainly the vertically integrated organisations that manufacture and distribute, both from the experience with counterparty risk that we all bore in the credit crunch and now through FSA guidelines are around the 10% exposure to counterparties for retail clients, are being forced to have very much a broad-panel approach to the providers of structural products.  Looking at ourselves, we state that we have 13 to 15 odd on the panel.

Yuri Bender: How do structured products fit into portfolios and which are the popular products that are currently being issued?

Oliver Gregson: I will tell you how they are used, at least by us.  We are taking the UK view in terms of how structured products are used in portfolios.  The FSA guidelines are pretty strong, so we will not advise our clients to have more than 25 per cent of what are – a vague and generic FSA term – investible assets in structured products and not to have more than 10 per cent exposure to any one counterparty. Although they are guidelines from the FSA, they are guidelines to a rule of suitability.

Yuri Bender: Does that include ETFs or are they in a separate bucket?

Nick Coghill: Well, this is the Pandora’s box, because you have guidelines to one counterparty that can cover structured products, but ETFs may be swapped back with a bank.  All the big funds will have derivative exposure, whether it is an MNG, a Threadneedle or a Schroders; they will have derivative exposure to banks.  It is quite a problem to put them into that, but I think that the guidelines are a good practice to go along with, and I think that they are being implemented.

Philippe Bongrand

Let us look at the Swiss banks.  We have talked a lot about retail, but if you look at the wealth investors, first of all not all worth investors are very sophisticated.  I think that what you tend to see is that the bank would advise the client to have something between 10% and 20% for various different reasons.  We have also talked about them not being an asset class.  I think that it very much depends.  Depending on how you have presented it and the education that has been completed, the client perspective is sometimes it is an asset class.  Of course, banks report it a bit differently.  I think that another dynamic is the difference between discretionary and advisory.  I think that what you see more now is that with discretionary clients the bank has the opportunity to seize opportunities and to act on the market, which may be very good for the client.  I think that on the advisory side, while you have talked about experience, experience has had an impact on clients, but if you open a newspaper in Switzerland you will see a lot of clients advertising all the time about structured products.  You see adverts from Vontobel, UBS, Credit Suisse and Julius Bär, and so the dialogue that you see is wealthy clients, rather than retail clients, coming to see their advisers and bankers and saying, ‘I have looked at this and it seems to be something that I would want to have in my portfolio.’  Then the discussion comes from the client as opposed to the bank.  I do not know if this type of dynamic occurs in other markets, but I think that there is much less advertising.

Oliver Gregson: I think there is going to be a polarisation in that dynamic, because the high net worth individual, whether they are categorised by the regulator as retail or not, is going to move increasingly towards the bespoke, customised reverse enquiry and/or advised structure, working with your counterparties and a wealth manager to put something together that is very customised.  The more retail client is going to get simpler, flow-based sorts of products.  I believe that this will be driven because you have this twin squeeze going on from providers and manufacturers.  It will be more expensive under Basel III capital rules to use this as a funding source.  Therefore I think you will need to get scale and volume into that end of the market, and that will allow you a bit of flexibility and resource to do the customisation at this end.

Yuri Bender: In these relationships, Jeremy, are clients coming to you and saying, ‘I have concerns or feelings about particular trends in the market at the moment, inflation, oil prices, commodities. What can you do for me in that area?’

Jeremy Beckwith: Yes, certainly the interest that we have had back from our advisory client base has been very strongly, ‘I am very worried about inflation,’ and we have put together a product to try and meet that so it pays out a lot in the event of high inflation.  That was a client-demand-led product.  Our own house view is that inflation has not been an issue, but we say to them, ‘If you are worried about inflation, here is a product that will offset that risk for you.’  So, we are able to do that.

What we have done is use structured products for access, so for example last year we bought the FTSE 100 Dividend Index, which was trading at a very crazy level.  That is not something that you could normally buy in a client’s portfolio, but in a structured product that was a very straightforward thing to do.  I try to create our structured products by timing.  If you return to March 2009, we put together a super tracker leveraged FTSE product, one for one on the downside and 175% of the upside for three years, and you could get fantastic terms.  There are points in the market when volatility spikes or collapses, and you can make use of that to say that these are very good terms for a certain sort of product, if that is what your view is, and you can really implement it very effectively and efficiently and generate real outflow.

Yuri Bender: What are the most popular underlying investments currently being used? Real assets such as commodities and hidden assets such as volatility are often mentioned by suppliers.

Nick Coghill: The unfortunate scenario that we are in, in the investment world today means we are having to do a lot more separating of the wheat from the chaff because we are over-spoiled for choice of investments, whether it comes to structures, funds – everything.  Unfortunately for advisers and investment managers, it is how they filter the plethora of Ucits launches that come out daily and structured products that land on their doorstep. It is tough, and I do not think that there is an immediate answer here to stop the raft of investment products, not just structured, that are coming through, including ETFs and the whole shebang.

Trading volatility is a very broad statement because there are lot of ways, both direct and implicit.  We are selling call options, and selling options is almost implicitly selling vol as opposed to specifically trading vol, VIX, V-stock and others.  Yes, there has been a growth in that; in my view, trading volatility is a hugely dangerous thing, and I have never known many people to be successful at it in the long term.  You have huge hurdles as to how you do that in terms of implied versus realised vol-curve.

James Bevan: There are also some very professional counterparties who want to eat your lunch.

Nick Coghill: It is a two-way thing.  To answer that, volatility as an asset class is hugely complicated.  It is traded day-in, day-out by hedge funds, institutions and people who know it.  I come back to my earlier statement: you should never ever do product for product’s sake, and that is one instance of an asset class – if you want to call it an asset class now – which should be solely the domain of the institutional investor.  You may get some executional-only people who want to trade VIX, but they had better know exactly about things like roll costs and commodities.  It is the same thing.  Structured products people may talk about volatility as an asset class, but it should really be up there with the professionals.

It is understanding what you are buying.  Long-volatility and short-volatility structures have been very successful and continue to be very successful where used appropriately and where you understand the risks and rewards.  A lot of the people who use them will go in as day-traders, and they can trade in and out without suffering.  To put it this way, it is not something that I would ever put through an IFA channel in a million years.

Oliver Gregson: I would not recommend most of my wealth management clients get involved in that space, unless they are at the very top-end and sophisticated.

Daniel De Fernando: When I first started working in this business, I remember that Dennis Weatherstone was the chairman of JP Morgan, and he had a motto which I think was: ‘If someone has a product that cannot be explained to me in two minutes, I will never buy into it.’ I have never forgotten that, and I do not think it should be forgotten.

Nick Coghill: For me it is the good old traditional equities, which are currently most important.  I think there is a lot of lovely talk about other asset classes, but again, is it applicable in portfolios and do they translate into the appropriate risk returns?  In a lot of cases, no.  Therefore, a lot of people look for it to gain access to those asset classes that they understand and it fits in.  I think I am on record as saying every year, ‘This is the year that we see a move away from the UK as a FTSE, as an underlying,’ and am on record as saying the exact same thing the next year because it has not changed, but it is what people understand as a geographical region that makes sense.

Daniel Freedman: My conclusion is that, for the right type of clients, they can be very useful products, and structured products should be considered by investment management teams, especially for exposure in areas that they cannot necessarily get to in the same way.  However, in the retail market my view is that these products are largely expensive, poorly marketed and badly regulated.

James O’Neill: I believe that overall on the retail market it is to do with clarity of products, acceptability of risk for the end client and a degree of responsibility by the manufacturer and the provider.  A whole lot of emphasis needs to be put on knowing the distributor besides knowing your client.  Therefore, if it is all manufactured in-house and sold through a commercial bank networking channel, there should not be a problem with these products for the retail network, provided of course that the products have followed an internal procedure so it is accepted that it is okay for the retail market.  On the institutional side, we see great opportunities and great growth there; it is a different market so I am very optimistic for the future use of these products in both the timing and market access aspects and general tailoring of portfolio needs from a leverage and from an income provision.

Daniel De Fernando: I will make four remarks.  The first one is that if you do not understand it in two minutes, then do not buy it, and if your client is not going to understand it in two minutes, do not sell it.  Secondly, think always of the client; what the investment return is, the beta and the alpha as well as all the expenses, before proposing any solution.  Thirdly, another reference to the referee – fair play.  Fourth, I take you point on education; make sure that the client, relationship manager and senior management are all educated.

Jeremy Beckwith: Structured products have a role in portfolios.  They can be used on the basis of market timing.  There are good times to buy certain sorts of structured products, you should try to take advantage of those, and indeed there are bad times to buy certain types of structured products.  They can be particularly useful in portfolios for accessing slightly odd asset classes or other things that you would not normally find in portfolios, and in general I am always very suspicious of anyone who wants to sell me one.  I design and create it myself, and then go and get the best price for it.

James Bevan: I would position my perspective by going back to first principles: that the fundamental challenge for investing is to deliver returns consistent with investors’ requirements.  Therefore, when considering structured products, one needs to be wholly focused on the risk and return characteristics that the product will deliver net of costs, accepting that those return characteristics are unlikely to have a conventional distribution of forward-looking returns.  However, I do think that structured products are an extremely significant means of wrapping exposures and varying risk and return characteristics to obtain a closer match to investors’ needs.

Oliver Gregson: I agree that they are an expression of implementation.  Going forward, I think that we have an incredibly fluid environment where the evolution is essentially being driven by three things: client demand, technology and innovation, and the regulatory environment.  That twin regulatory squeeze, with the headwinds at the point of sale around disclosure and post-sale obligations and the prudential backing measurements around capital requirements, are going to require providers to move away from a vanilla approach; that is just not going to work anymore.  Also, you are going to need to look at structured products, structured deposits, potentially structured funds and potentially fully collateralised structured notes.