Simplicity the order of the day

After a poor start to the year, structured products are once again attracting interest from investors looking to take advantage of the opportunities on offer in the market. Although investors remain cautious about taking on market risk, and remain concerned with protecting their capital, they are aware of the potential upsides and that structured products can offer a way of accessing them.

“Volumes were down in the first half of the year, but we have seen an increase from May and June onwards,” explains Jonathan Kent, executive director of derivatives marketing at JPMorgan in London.

He explains how the structured products market suffered at the end of 2008 and in early 2009 for two reasons. “Firstly, people finally woke up to potential credit risk. Secondly, the market per se was falling sharply.”

Wealthy private clients appear to be prepared to take issuer credit risk again, which was not really the case six months ago, but they are now approaching their investments in a very different manner.

Shortened maturities

The issue of credit risk is driving investors to look for different kinds of products that they would have gone for in the past, and the average maturity of products has been falling. “If you roll the clock back the classic product had a six to seven year maturity,” says Mr Kent. “We are now seeing a lot more short-dated, one to two year autocall products.”

JPMorgan has been issuing Ucits compliant funds as a way of protecting investors against credit risk, since funds tailored to the Ucits III EU directive requirements must have sufficiently diversified underlying investments.

Mr Kent explains that simpler products are the ones which are now in greatest demand. “Investors want to be clear about what will happen to their investment if the market behaves in a certain way,” he adds.

The trend towards simpler and more transparent products is echoed by Uwe Becker, managing director within the investor solutions team at Barclays Capital. “In the aftermath of the Lehman fallout, with all the turmoil that we have seen in the markets, simplicity and transparency are the key,” he explains. “It is all about transparent structures without any features that investors might not spot.”

Mr Becker believes investors remain cautious, and are sceptical about whether the recent rallies will prove to be a long-term trend or not. He explains that in recent weeks Barclays has seen increasing interest for fixed income and bonds, and that products they are rolling out in Europe are proving successful, particularly in Switzerland and Germany.

A safe haven

Clients are looking for safety in their investments according to Benoit Petit, head of private banking sales for the global markets solutions group at Société Générale.

“The big trends are the following: Firstly clients are looking for more protection. They don’t want to take long-term risks so our structures are shorter in terms of maturity,” he explains.

“Clients are looking for safer structures. In the context of very, very low interest rates it was difficult to offer attractive solutions on the capital guarantee side, so we are delivering a lot of products with protection but no capital guarantee.”

Although the demand for simple and transparent products is increasing, there is still a market for the more innovative types of products among certain clients, believes Marc El Asmar, co-head of sales for Europe, Middle East and Africa for the global markets solutions group at Société Générale.

“I would mitigate that on a global level in Emea, simplicity, to a certain extent, has been a rising concern for the vast majority of clients,” he says.

But the ability of structured products to offer more complex solutions to investment needs remains of interest to certain groups of investors, believes Mr El Asmar.

“If you look at the higher ends of wealth management you still have a requirement for adaptive structures to match complex needs, whether in terms of potential financing or potential structures, hedging or acquisition of stocks and so on,” he explains. “Things that, I would not say are complex, but are either innovative or trying to match specific needs.”

Credible providers

The Lehman collapse last autumn has had a big impact on the way in which private investors and distributors view the issue of counterparty risk. Distributors’ reputations were damaged by the fallout from the collapse. Many banks were selling products without clearly stating who the underlying issuer was, leaving many investors to be unaware of the banks they were dealing with. This is no longer the case.

“A big difference from two to three years ago is that people are making a clear distinction between who is a credible product provider and who isn’t,” explains Mr Becker at Barclay’s Capital.

“The situation back then was that the best price was right; this is certainly not the situation anymore. There is a lot of attention on who is the product provider, what credit am I actually buying with this structured product. That really dictates the game now.”

This flight to quality and renewed emphasis on established names may benefit the bigger players. “As far as the structured products industry for private individuals is concerned there is a very strong preference for players who are well established in the market and who have a track record, where investors can have the confidence that they will be still there to service you in a year’s time or even in five years time,” says Mr Becker.

“That is so important nowadays. People want to hear about the strategies of the product providers, about their long-term commitment to the market in question.”

However this does not mean that the bigger players will come to dominate the market, as increased transparency should lead to more competition in terms of pricing. “We are not complacent and saying that the world has changed and this is how it is going to remain for the foreseeable future. As markets recover there is definite potential for second tier players to return to the market. We are pulling up our sleeves because we expect the market to become more competitive,” states Mr Becker.

Mr Petit agrees that private banks are now being far more careful with who they choose to do business with. “Last year many private banks were trading with a lot of investment banks. This year they are looking pretty deeply at issuer risk. They are choosing issuers with very good names. They are becoming very selective,” he says.

Right to worry

The fact that many investors who were not aware of counterparty credit quality are now looking at the factors that affect the issuer’s credit quality, and are no longer solely concerned with price, can only be a good thing according to SocGen’s Mr El Asmar. “Clients are very concerned about the credit of their issuers or the banks that they are buying products from. I would say that is a positive concern to have,” he states.

The recent rallies in global equity markets has led many investors to start thinking about increasing their exposure to the asset class, and so the outlook for structured solutions is positive, believes Mr El Asmar.

“People have been sitting on cash in a wait and see stance. Now they are thinking that they may miss out on opportunities in terms of timing the market. The last two months have been good and we are forecasting a second half of the year in line with the last two months,” he adds.