Transparency top of investors' wish lists

Indiscriminate use of algorithmically-generated indices in structured products has diminished this year, but there is still an appetite for the more transparent products, and for those that provide exposure to assets that are otherwise difficult to access. Today, an algo trading strategy used to create an index around which a structured product will be wrapped, is much more likely to be systematic and explicit so that its risks can be easily understood.

Many providers offer a product that uses an algo to optimise the roll of futures contracts with differing maturities. These have particularly appealed to commodity investors who have been disappointed with simple trackers and are looking at ways of mitigating the negative roll yield. Algo-constructed indices are also commonly used to create structured products to play the interest rate yield curve and to replicate a hedge fund strategy such as simple paired long/short buckets of equities. The important feature about these applications is that the goals and methodology are transparent and clearly managed, with little or no possibility of subjective interference.

Nicolas Cagi Nicolau, global head of structured products solutions at SG Private Banking, says many products built around managed indices were promoted before the crisis, but their popularity has since declined. “Clients want to know what they are buying – the level of guarantee and to invest directly in the underlying itself, rather than give the opportunity and freedom to the investment banks to manage the index,” he says. “The only interest in indices is if they would otherwise find it difficult to access the underlying, such as commodities, and then they want to clearly identify the risk. We’ve noticed during the last few weeks that some investment banks have started to promote these solutions again but we are very cautious in terms of selection and haven’t validated these solutions.”

The year could be splitting into two halves, however, with the first seeing a move to ‘back to basics’ products and an emphasis on vanilla fixed income products as investors avoided volatile equity markets; while the second half has seen a more positive outlook with a greater demand for simple directional equity-linked products.

One of the issues in the markets is how much liquidity has hit bond markets, says Johan Jooste, portfolio strategist at Merrill Lynch Global Wealth Management, and this has manifested itself in demand for yield curve products. “These structured notes sell well because there is sufficient transparency and sufficient liquidity in the underlying,” he says.

“Even where the strategy is complex, such as certain hedge fund replication strategies, clients prefer to see a simplified wrapper,” agrees Jo Ninian, responsible for custom index creation at Morgan Stanley, and provided the algo makes sense to clients, she says demand is starting to trickle back.

While the standalone products sold to individuals tend to include an element of capital protection, portfolio managers are happy to take on the full exposure of Delta 1 products.

“An area which is generating interest amongst private banking clients is multi-asset algorithmic strategies, which are comparable to the hedge fund space but have the advantage of offering daily liquidity with tight bid/offer spreads,” says Jane Balen, head of private banking solutions, Europe, at Barclays Capital. “While there are ongoing concerns about transparency in hedge funds, our algorithmic strategies can be made public and that transparency helps their credibility in the current market conditions.”

This is a far cry from the days when indices were created to replicate hedge funds at the behest of private clients looking to invest in strategies that only hedge funds had access to, only to find that the hedge funds arbitraged the index on their own strategies. “Many clients have been reading the emerging market research and looking at ways to explore these opportunities,” says Massimiliano Delle Donne, co-head of wealth solutions, Europe, at Barclays Capital.

“Much of the interest has been in capital protected products, especially in taking a view on the appreciation or depreciation of a basket of emerging market currencies versus the dollar.”