Taking advantage of difficult markets

The aggressiveness with which Barclays Capital wheeled out its structured products last year is showing no sign of moderating, according to a senior official at its private banking business. Pierre Bes, managing director and head of private banking coverage, Europe, believes BarCap is taking advantage of the difficult market conditions and increasing market share in the first few months of 2008.

“One of the main catalysts for this success is our blend of simple, accessible and diverse structured solutions within a well integrated multi asset platform,” says Mr Bes. “Clients reward us for being even closer to them in times when some of our competitors are losing their focus”.

In the last 12 months the flow of structured products has not been significantly interrupted as a result of credit market issues, and even more so for high net worth private investors. Mr Bes and his unit are now finding they are receiving client calls from sources of private wealth money outside the traditional world of private banks. A new breed of wealth manager is joining the more traditional institutions like pension funds in the business of wealth preservation and creation.

“We are seeing caution from mass affluent and retail investors, whereas more sophisticated players are willing to take advantage of the many opportunities created by a highly volatile environment,” affirms Mr Bes, “and sophistication does not always come with a high level of assets under management.”

Retail funds often react to market distress with a “wait and see” approach, he believes, and this creates opportunities for cannier investors to strike. He explains: “Retail funds tend to invest in markets that have performed well recently: the challenge is to channel to clients the rationale of investments based on a value approach, which in the long term always proves to be the best. “However the response from retail investors can be too slow sometimes and ‘following the momentum’ is often an irresistible temptation,” he adds.

Financial stocks are a good example of this herd mentality. Idiosyncratic risk has been heavily influencing the performance of stocks of commercial and investment banks, as a number of market makers are convinced that further institutions could share Bear Stearns’ fate. However it is difficult to imagine a scenario where the whole sector is brought down, hence the advent of structured products geared to take advantage of this value gap.

Increasingly these products are allowing exposure to financial stocks with non linear payouts, such as ‘Best-of’ structured solutions, where the investor receives an above market coupon if only one financial stock in a basket of three or four has a performance above a predetermined level, over the investment period. BarCap recently launched an auto-callable product with a ‘best-of’ feature, which pays a 10 per cent coupon as long as the ‘best of’ stock does not fall more than 15 per cent next year. Another BarCap equity-linked note, released last month, targets the earnings of US companies.

According to Mr Bes, companies with good balance sheet ratios generally over-perform within a month of publishing their results, especially when solid fundamentals are combined with a positive surprise in the earnings figure, versus the expectations of analysts. “This honeymoon effect, due to the relatively slow processes of portfolio readjustment of larger institutional investors, lasts a month or two, so this is the moment to re-balance the stock selection,” he recommends, claiming this strategy has yielded a net rate of return of about 16 per cent over the last seven years.

“Over the long term it tends to be de-correlated with general equity market movements, and we see it as a quite powerful alpha-generating tool if combined with a hedge on the market indices,” he adds. The market has witnessed the launch of similar products this month. Boutique firm Blue Sky Asset Management’s ‘Accelerated Recovery Plan’ is a structured product targeting recovery in the UK banking sector. According to BSAM, leading UK banks’ average share price has tumbled 35 per cent since April 2007. “We believe we are now at a point where it is reasonable to anticipate the beginning of the end to the turmoil seen in the stocks,” says CEO Chris Taylor.