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Institutional Structured Products. 9 th May 2014. Agenda. Who are Catley Lakeman Securities? What is a Structured Product? Key Categories of Structured Product Two case studies Costs / Liquidity How we support our clients Appendix. Who are Catley Lakeman Securities?.
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Institutional Structured Products 9th May 2014
Agenda • Who are CatleyLakeman Securities? • What is a Structured Product? • Key Categories of Structured Product • Two case studies • Costs / Liquidity • How we support our clients • Appendix
Who are CatleyLakeman Securities? • What We Do • Institutional sales, structuring, pricing, execution, servicing for: • Defined return and market participation structured products • Delta one, ETFs, ETPs, trackers and structured UCITS • Research, analysis, portfolio manager training • Portfolio hedging, options modeling • Legal, tax and regulatory process advice • Highlights • Est. August 2008 • Unparalleled experience • Exceptionally qualified team of eight • Leaders in institutional market for securitised product • Growing reputation for hedging advice and execution • £3bn originated and executed since August 2008 • £955mn originated and executed in financial year to July 2013 Business Split By Product Type (Data to Q4 2013)
Where CLS sits… Institutional Investor Client Discretionary Portfolios
So it’s key to understand counterparty risk? What we really care about is how stable the bond spread is! Source: Bloomberg, data as at 9-May-2014
FIRST STEP Buy Zero Coupon Bond from Bank • First step: buy Zero Coupon Bond from bank, it sits as Senior Unsecured Debt on the bank’s main Balance Sheet • Net Amount Remaining to Invest: 11.21p • Note: the 11.21p could be spent on a guaranteed coupon stream, what would this be called? • → A bank corporate bond £1 to invest 5 years ZCB now worth £1* £1 5yr zero- coupon Bond/ Swap Cost: 88.79p *The ZCB is discounted at the respective interest swap rate for the term, plus the bank’s funding level, to return 100p at maturity
SECOND STEP Sell Knock-In Put • The next step is to sell a knock-in put on an index the investor is looking for exposure to • Net Amount Remaining to Invest: 21.67p • Note: all puts are expensive due to a skewed demand for downside protection in the derivative markets • EG: how probable do the models think it is that the FTSE will be below 4000 points in 6 years time? • → 21% chance (as of May 2014, updated from original research piece ‘Structured Investments and Value’) £1 to invest 5 years ZCB now worth £1 £1 5yr zero- coupon Bond/ Swap Cost: 88.79p Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’) Cost: 10.46p Knock-In Put: Has the FTSE fallen by more than 40%?
THIRD STEP Choose Upside Package • The final step is to choose your upside package- for consistency we will stay with FTSE • Fee of 1 – 1.5% • Net Amount Remaining to spend on Upside Package: 20.17– 20.67p • Bullish? → Accelerator: geared participation in rising markets • Bearish? → Synthetic/ Autocall: both provide a positive return in flat to falling markets* • Somewhere in between? → Booster £1 to invest 5 years Option package Providing Economic Return ZCB now worth £1 Option package Providing Economic Return £1 5yr zero- coupon Bond/ Swap Cost: 88.79p Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’) Cost: 10.46p Knock-In Put: Has the FTSE fallen by more than 40%? *so long as markets haven’t fallen by more than the put, ie 40% down
UPSIDE PACKAGE Accelerators • HSBC 5.5 year Fixed Rate Bond • Price of 1 FTSE call option today: 10.08p • Therefore the investor can afford: 20.17/ 10.08p • → 2.00 call options 20.17p left to spend In other words: 200% participation in the FTSE over 5 years • How do Accelerators fit into portfolios? • These have been very popular this year, with clients bullish beginning of year view • Not usually held for more than 1 to 2 years
Performance of the US Accelerator Series The calculations above are based on gross reinvestment of proceeds. Average weighted entry/exit levels have been applied based on actual investor flows, we believe this to result in a conservative estimation of cumulative performance. Source: Bloomberg, data to 08-May-14
Where does it fit? Source: Bloomberg, Financial Express, data to 6-May-14
UPSIDE PACKAGE Synthetics • HSBC 5.5 year Fixed Rate Bond • Guaranteed coupons: ReverseConvertible • Coupons contingent on an index being over a certain level: Digital • Coupon contingent on an index being between a range: Range Trade / Range Accrual • Note: all of the above can be structured to pay income 22.18p left to spend • How do Synthetics fit into portfolios? • 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
UPSIDE PACKAGE Synthetics • This shows the evolution of a live trade: MANAGER CONSIDERATIONS & DECISIONS HOW TO GET HIGHER YIELD RESULTING STRUCTURE HSBC 6y Fixed Rate Bond Yield : circa 2.9% 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 4090 points. Yield : circa 4.7% HSBC 6y FTSE Digital At what level should the lower barrier be? Coupon paid annually as long as the FTSE is over 4090 points. Put coupon at risk (via lower barrier) Yield : circa 5.0% At what level should the upper barrier be? 5.23% annual, accrued daily for every day the FTSE closes within the range of 4090 to 8864 points. HSBC 6y FTSE Range Accrual Put coupon at risk (add upper barrier) Yield : circa 5.23% (Rolled-up version, accrued max 6*5.58% p.a.) *All pricing as at circa May-2014
HSBC 440 FTSE Daily Range Accrual (7.0%) Traded example, semi-annual, HSBC 440 FTSE Income (3.5% s.a. Daily Range Accrual) Note *Example structure first traded Oct-12
Mark-to-Market Source: Bloomberg, data as at 8-May-14
Sterling Interest Rates • Sterling Interest Rates • Grinding lower, 10% autocall coupon equates to 15% in 2007 (ceteris paribus) • Source: Bloomberg (08-May-2014)
UPSIDE PACKAGE Autocalls • HSBC 5.5 year Fixed Rate Bond • Snowballing annual coupon which can redeem early if the index is over a certain level • These barriers typically fall each year • Note: Synthetics have a tenor of 6 years, Autocalls have an expected life of roughly 2 years. • → Rates concern? 22.18p left to spend • How do Autocalls fit into portfolios? • Performance of Defensive Autocallsis predictable and defined • Bull market: Underperform • Bear market: Likely to outperform • Flattish market: Outperform significantly
Current Yields Source: Data as at 08-May-14
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
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
Full Intra Day Secondary Market Liquidity • Zero Coupon Bond • A notional swap from the bank’s Treasury Department • This is cancellable at any point • They are ultimately notional- do not need to be sold, hedged or replaced. • Option Package • Calls and put options are, logically, derivatives of their underlying risk assets • Therefore, the options market can only become illiquid at some point after the underlying market becomes illiquid Option package Providing Economic Return £1 5yr zero- coupon Bond/ Swap Cost: 88.79p Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’) Cost: 10.46p • Past Exceptions • Close Brothers & ELDerS- collateralised with British, Irish and some Icelandic banks and building societies. • Retail Structured Product market.
FTSE 100 Futures Daily Volume Trading in the top ten traded UK stocks is 29% of FTSE 100 futures volume Source: Weekly average data, as at 01-Oct-13
The Operational Process • Investment Manager checks price with Catley Lakeman (via phone or Catley Lakeman website) • Investment Manager places dealing instruction to Dealer at Stockbroker • Dealer sends request to Catley Lakeman • Catley Lakeman sends email to Stockbroker Dealer and Bank Structured Products Desk with price and notional • Dealer confirms • Bank confirms and executes • Note: Stockbroker faces the bank directly, they do not face Catley Lakeman.
DISCLAIMER Disclaimer This is a marketing communication and has not been prepared in accordance with legal requirements designed to promote independence of investment research and is not subject to any prohibition of dealing ahead of the dissemination of investment research. The information in this document is derived from sources believed to be reliable but which have not been independently verified. Any prices included within this communication are for indicative purposes only. Catley Lakeman Securities makes no guarantee of its accuracy and completeness and is not responsible for errors of transmission of factual or analytical data, nor is it liable for damages arising out of any person’s reliance upon this information. All charts and graphs are from publicly available sources or proprietary data. The opinions in this document constitute the present judgment of Catley Lakeman Securities, which is subject to change without notice. This document is neither an offer to sell, purchase or subscribe for any investment nor a solicitation of such an offer. This document is intended for the use of institutional and professional customers and is not intended for the use of private customers. This document is not intended for distribution in the United States of America or to US persons. This document is intended to be distributed in its entirety. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient. Catley Lakeman Securities is regulated by the Financial Conduct Authority. Firm FSA Reference No. 484826. Catley Lakeman Securities is the trading name of Catley Lakeman LLP. Registered Office: One Eleven Edmund Street, Birmingham. B3 2HJ. Registration Number: OC336585