Structured products have largely delivered on their promise to offer protection, but continued evolution is necessary
Only one thing is certain when trying to predict how the UK structured product marketplace will look 15 years from now – it will not resemble its appearance today.
New assets will be used as bases for products, structurers say. The range of vehicles used to deliver them will broaden. And investors may benefit from the development of secondary market trading.
Last year there were 214 UK retail structured products, according to anlaysts Future Value Consultants. Peers Arete Consulting say last year they held £43bn. This was a jump, in both cases, from 2005, when 103 UK products holding £26bn.
Analysis of the marketplace suggested during the credit crunch most funds fulfilled the key purpose of their design – to protect or limit the downside investors in them would have faced investing in markets directly.
Most investors in structured products due to mature last year ended their investment no worse off than they began it, despite global shares falling 43% the year before. This was because, of 766 products due to mature in 2009, 508 or roughly two thirds of the total, offered full capital protection.
Perhaps fearing markets would topple after the onset of the credit crunch in mid-2007, UK investors put almost 50% more money into structured products in 2008 than they had the year before.
Marc Chamberlain, Morgan Stanley executive director for structured products, says most UK retail products allow for up to 50% falls in the underlying asset before investors face the prospect of asset impairment.
“Even from its heights, the FTSE 100 did not fall by half. What would have been triggered would have been barriers set at 20% or 30% falls, where the barrier observation was daily, but they were much less prevalent.”
The FTSE’s 40% since the crisis eased last March moved products still waiting to mature away from the danger zone of clients losing part or all of their money.
Robert Corbally, product development manager, UK, at Aviva Investors, says the UK index will remain the basis “for the large majority of UK retail structured products” because of how easily recognised it is.
Aviva is accelerating the roll-out of products after launching three FTSE-linked tranches since last year, but Corbally does not rule out using more esoteric asset classes in future, such as commodities and gold.
Morgan Stanley’s Chamberlain says there are practical limits on what assets can be used, as very volatile or illiquid ones may be difficult to price and trade, so are less easily employed.
He says: “I would expect the FTSE to take pride of place for some time to come [as basis for UK retail products] but you are able to tailor products to fit investors’ needs using varied underlyers. For example, we have issued product linked to commercial property, Asia ex Japan [equities] and inflation.”
Azad Mahavar, head of structured products for the UK and Irish markets at BNP Paribas, says, in future, products using benchmark indices will exhibit “a different way of treating those indices.
“When a structured product has bad performance because the index is doing badly, both the client and investment bank are losing money. You will therefore find more risk controls on top of the index, using options during the life of the product.”
BNP Paribas recently launched a product as an open-ended fund based on the FTSE, selling call options on top of the index, for example.
Mahavar says: “We add systematic daily trading of the call option, which gives you a better risk return profile. A traditional asset manager could not do this because of the operational burden. It transforms the old strategy.”
Mahavar concurs the FSTE will likely still underlie most structured products for retail UK investors, but he adds: “I am sure there will be new underlying assets we do not use yet. Trading volatility has become almost commonplace for high net worth individuals, for example, and no-one would have thought of that three years ago.”
Barry Hoolan, in regulatory structuring at the London office of BNP Paribas, says there could also be a change – up to a point – in how structured products are delivered.
In the past, he says, certificates and notes have been favoured by investors, but this could change as some come to prefer products that are delivered in fund format.
He says: “From a UK perspective, this time last year a lot of commentators were completely shying away from notes and any element of third party risk, and saying that most people now think structured products providers have to deliver products in fund format. But the reality is slightly different.
“Ucits structures… take a lot longer than a note to set up. For most clients, now the easiest way for a private bank or high net worth individual to buy a product is still via a note or a certificate. A certificate can be put together in five business days, buying it directly from BNP Paribas, for example.”
He says constraints in counterparty risk that Ucits rules carry, and the ease of delivery of notes and certificates, will mean the latter remain important.
Morgan Stanley’s Chamberlain expects fund vehicles to grow in popularity, too, and says this could also help structured products fit more easily onto more distribution platforms.
He adds secondary trading of structured products by retail investors could also evolve in years to come, as has happened with discretionary clients over the past four years.
However, he adds a thorough understanding of the product and its pricing during its life must be gained before this can flourish.
He says: “Once that occurs, these products will truly have entered the mainstream.”
