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Institutional Structured Products. October 2013. Agenda. Catley Lakeman Securities / Counterparty Risk How are Structured Products put together? Key Categories of Structured Product How do they fit into client portfolios? Costs / Liquidity Why Use Structured Investments? Appendix.
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Institutional Structured Products October 2013
Agenda • CatleyLakeman Securities / Counterparty Risk • How are Structured Products put together? • Key Categories of Structured Product • How do they fit into client portfolios? • Costs / Liquidity • Why Use Structured Investments? • Appendix
Catley Lakeman Securities • Founded July 2008 • Team of 9 • Combined investment sales experience –42 years • Combined structured investment trading experience –34 years • Combined structured investment specific experience –54 years
Counterparty Risk • FSA authorised securities and futures firm • Outsourced origination and distribution business, representing seven banks on a contractual basis • Sell and support (ie in both the primary and secondary markets) private placement securitised derivative investments to professional asset managers and institutions in the UK Source: Bloomberg, data as at 30-Sep-2013
What are Structured Products? • A structured product is a defined-return investment based on the performance of an underlying asset • Factors to determine at the outset: • Underlying asset – equity indices, commodities, interest rates, etc • Payoff – depends on your investment view, the risk/ return profile, income vs growth • Counterparty – mark-to-market considerations, diversification of issuers
Capital Protected FTSE Back in 2005 • Estimation of 170% Barclays 5 year FTSE Accelerator Bond (Traded 1-March-2005): • Matured at 117p (estimate) • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 74.61p • Aggregate Costs 1.49p • Amount to invest 23.9p Price of 1 call option atMarch 2005 14.06p Therefore with 23.9p, investor can buy 1.7x call options • →170% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash
Capital Protected FTSE Today • Indication of the same 5 year capital protected participation structure today, with an AA- rated issuer: • Hence why these structures are not traded today in the current pricing environment • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 89.84p • Aggregate Costs1.49p • Amount to invest 8.67p Price of 1 call option today 12.10p Therefore with 8.67p, investor can buy 0.71x call options • →71% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash
Partly Capital Protected FTSE Today • Selling FTSE downside does look good today. Indication of a 5 year structure today with soft capital protection at 60%, with an AA- rated issuer: • These structures can be a good alternative to passive or quasi-passive long only funds Option package Providing Economic Return • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 89.84p • Aggregate Costs 1.49p • Old amount to invest8.67p • Sell put risk premium 13.52p • New Amount to invest 22.19p Price of 1 call option today 12.10p Therefore with 22.38p, investor can buy 1.83x call options • →183% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’)
Partly Capital Protected FTSE Back in 2005 • How would this have looked in 2005? Estimation of a 5 year structure with soft capital protection at 60%, AA- rated issuer: Option package Providing Economic Return • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 73.79p • Aggregate Costs 1.49p • Old amount to invest 24.72p • Sell put risk premium 4.04p • New Amount to invest 28.76p Price of 1 call option atMarch 2005 14.60p Therefore with 28.76p, investor can buy 2.05x call options • → 205% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’)
Key Categories1. Accelerators / Supertrackers2. Defensive Autocalls3. Range Accruals
Categories of Structured Products SELLING VOLATILITY DEFINED RETURN YIELD ENHANCEMENT Autocalls Defensive Autocalls Worst-Of Autocalls Sit alongside: Equity income funds and absolute return funds AUTOCALLS Synthetic Zeros Digitals Range Trades Range Accruals SYNTHETICS Sit alongside: ZDPs Reverse Convertibles Digitals Range Trades High Income Range Accruals Inflation Plus INCOME Sit alongside: Income funds PARTICIPATION Accelerators Supertrackers UNCAPPED Sit alongside: Large cap / core long only funds and ETFs CAPPED Call Spreads ACCESS TO A PARTICULAR UNDERLYING Usually participation in the form of an Accelerator, (but not always) Sit alongside: Other vehicles accessing the same underlying asset
1. Accelerators / Supertrackers2. Range Accruals3. Defensive Autocalls
Construction • HSBC 5.5 year Fixed Rate Bond • Yielding roughly 3.3% per annum at time of issue • Remove coupons • Present Value of coupon stream over 5.5 years: 17p • Left with an HSBC zero coupon bond worth 83p • Incorporate ‘soft protection’ • 60% soft protection on S&P 500 at maturity • Sell knock-in put: 12.5p • Incorporate upside • 100 – 83 + 12.5 = 29.5p to spend • 1 S&P call option is 16.5p; 29.5 / 16.5 = 1.79 call options HSBC 5.5 year Fixed Rate Bond Remove Coupons Incorporate ‘soft protection’ Incorporate upside All data as at time of issuance (Feb-11)
Mark-to-Market Source: Bloomberg, data to 29-July-13
Performance • Since launch performance: 40.59% versus 29.75% sector average in the below list of funds Source: Bloomberg, Financial Express, data to 26-Sep-13
How do they fit into client portfolios? • Seen by many as a cost-effective ETF replacement • Given 90% of respondents to the 2012 questionnaire were bullish, it is likely we will see more of these structures over the next year • Not usually held for more than 1 to 2 years
1. Accelerators / Supertrackers2. Defensive Autocalls3. Range Accruals
Payoff Unless the capital protection has previously been breached
Mark-to-Market Structure outperformance to date: 9.77% Structure annualised volatility: 14.51% FTSE 100 annualised volatility: 19.93%
Performance • Called in Year 2 (8th October 2012), with the FTSE at 5841.74 points • Over the two years since launch, the structure doubled the return of the market with less volatility Source: A selection of popular UK funds, all rated AAA/AA by Citywire
How do they fit into client portfolios? • Performance of Defensive Autocallables is predictable and defined • Bull market: Underperform • Bear market: Likely to outperform • “Flattish” market: Outperform significantly • AutocallBacktest Analysis – illustrating where outperformance tends to occur
Cost and Liquidity of Institutional Structured Investments • Cost/Fee structure of Institutional Structured Investments • Costs typically between 0.5% to 2.0% • How liquid are Institutional Structured Investments? • Can I buy and sell them? • Full Intra-day secondary market liquidity • Institutional structured investment s will price intra-day • Liquidity has existed on every single trading day for the entirety of the Institutional Market (i.e. over the last ten years, encompassing the Financial Crisis) • Liquidity exists at the level of the underlying they are referenced to. • For example, examine the liquidity of S&P 500 or FTSE 100 futures. • Consider for example volume traded on S&P 500 futures – current average for the last weeks trading is $106.8Bil per day * *Source: JP Morgan Global Equity Derivatives & Delta One Strategy 26th July 2013
Why Use Institutional Structured Investments? • Why use Structured Investments in a portfolio? • They can be tailored to an investors’ specific requirements • They offer an investor access to a wide variety of underlyings (equities, indices, interest rates, inflation, commodities etc) • They can be structured via a variety of different outcomes at maturity, that are generally very simple to understand • They tend to do ‘exactly what it says on the tin’- both the returns and the risks are easily definable • As are the costs • They should be used as an active investment, which is facilitated by a liquid secondary market (they have proved to be almost the most liquid asset you can hold) that CLS services
Appendix: Market Colour Data • Rates, Credit and Volatility • Sterling Interest Rates • Grinding lower, 10% autocall coupon equates to 15% in 2007 (ceteris paribus) • Source: Bloomberg (30-Sep-2013)
Appendix: Market Colour Data • Rates, Credit and Volatility • Credit • Clients continue to chase quality Source: Bloomberg, data as at 30-Sep-2013
Appendix: Market Colour Data • Rates, Credit and Volatility • Volatility in a bit more detail • Source: Catley Lakeman, JP Morgan Derivatives and Delta One Strategy, Bloomberg (17-June-2013)
Range Accruals • The other success story over the last year, beyond autocalls • With the backdrop of falling rates, falling vol and tightening credit, in most cases these structures have outperformed the market
Construction (‘Synthetics’) This slide shows the evolution of a live trade. MANAGER CONSIDERATIONS & DECISIONS HOW TO GET HIGHER YIELD RESULTING STRUCTURE HSBC 6y Fixed Rate Bond Yield : circa 3.00% Which underlying should the structure be linked to? FTSE Put capital risk HSBC 6y FTSE Reverse Convertible To what extent is the manager prepared to put capital at risk? Soft protection at maturity at 3500 points. Yield : circa 5.00% HSBC 6y FTSE Digital At what level should the lower barrier be? Coupon paid annually as long as the FTSE is over 3500 points. Put coupon at risk (via lower barrier) Yield : circa 6.85% At what level should the upper barrier be? 7% annual, accrued daily for every day the FTSE closes within the range of 3500 to 7500 points. HSBC 440 6y FTSE Range Accrual Put coupon at risk (add upper barrier) Yield : circa 7.00% Any additional considerations? In this instance the investors wanted semi-annual income, so the structure pas up to 3.5% semi-annually. *All pricing as at circa early Oct-12
HSBC 6y FTSE Reverse Convertible (5.00%) *All pricing as at circa early Nov-12
HSBC 6y FTSE Digital (6.85%) *All pricing as at circa early Nov-12
HSBC 440 FTSE Daily Range Accrual (7.0%) *All pricing as at circa early Nov-12
Eg: HSBC 363 FTSE Daily Range Accrual (8.0%) Source: Data as at 29-Jan-13
Mark-to-Market Source: Bloomberg, data as at 17-June-13
PARTIALLY CAPITAL PROTECTED STRUCTURES 6 year Today • How would this have looked in 2005? Estimation of a 6 year structure today with soft capital protection at 60% Option package Providing Economic Return • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 87.14p • Aggregate Costs 1.49p • Sell put risk premium 18.02p • Amount to invest 29.39p Price of 1 call option today 13.10p Therefore with 29.39p, investor can buy 2.24x call options • → 224% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’) Pricing as at circa mid June 2013
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