Lehman debacle draws focus towards structured products

The panel discusses heightened interest in structured products since the Lehman collapse

This week's Conjecture is on the topic of structured products, six months on from the collapse of Lehman Brothers and the resulting heightened interest in the product type.

Things have stabilised since then, and discussing the opportunities are Nick Coghill, managing director, UK institutional and retail structured solutions business at Morgan Stanley, Alan Thomson, head of structuring at Aviva Investors, Chris Taylor, CEO, Blue Sky Asset Management and Steven Goldin, head of strategy and custom indices, EMEA, Standard & Poor's.

We are now six months since Lehman went down, how have things developed?

Steve Goldin (SG): If you look back to last year, structured products did really well, considering the other investment product areas like hedge funds or traditional asset management.

There was about a 10% increase in assets and £270bn in issuance. There was greater issuance in the second half of the year versus the first half. In the UK, if you go back a few years, there was about £7bn in sales, and we are already hitting that figure in structured products.

Where does the UK market sit, relevant to the rest of the world?

Chris Taylor (CT): In terms of the issuance volume, the structured products industry is enjoying exponential growth. Clearly Lehmans was a significant event over 2008. But since that point, people have responded to the obvious focus on counterparty risk and while that underpins all research emphasis today, it is more about the economic drivers currently and what clients are looking for as solutions to interest rates at historic lows and equity market volatility at all time highs.

Nick Coghill (NC): Certainly the retail space has continued to grow, products have obviously become a lot simpler and the explanations have become a lot clearer and that is continuing to grow all the time.

In addition to retail, in the UK discretionary world we have seen increasing use of structured investments within discretionary asset management portfolios in the UK. This has always been around but has grown hugely over the last few years, probably now representing about 5% to 6% of a client's discretionary portfolio.

Is this being driven by disaffectment with actively managed mutual funds?

NC: Within the advice space, it is a choice of investment. I would not say they are completely different product spaces but they can complement each other.

While they are not the Holy Grail, they should be considered and used alongside traditional investments such as mutual funds and ETFs, as a potential alpha-generating investment or offering a degree of protection in the event of market falls. We have seen this in the case of gaining exposure to the US markets.

So I would not pitch them off too much against each other in this space but some people in the investment management industry like to do that.

What has brought Aviva Investors into the market at the moment?

Alan Thomson (AT): Aviva Investors has certainly been in the UK structured product market in the past through Norwich Union, but it is fair to say it has been more about opportunism rather than seeing it as a main strategic target.

That has changed. The Aviva Investors executive has decided structured products will be one of our main focuses. They have been very active in other countries in Europe and elsewhere in the world, particularly the US.

We have created a centralised structured solutions team within Aviva Investors, that will look after structured products issuance for Aviva Investors globally.

Timing wise, it is opportunistic for us to be coming to the market now. Historically low interest rates and high volatility and the turmoil that has been going on in the market, have really raised investor awareness of risk and that really drives demand for fiduciary structured products.

What exactly is meant by structured products, given the use of more than one term?

SG: There are three elements - the portfolio itself; the payout - this could be principal protection plus a limited amount of upside; and the packaging or wrapper.

A traditional fund is discretionary, whereas a structured product is passive. A traditional fund is linear, meaning if the market goes up, the fund tends to go up, if the market goes down, the fund tends to go down, whereas structured products tend to specialise on non-linear payouts.

CT: I would characterise structured products as offering or being defined by a formula-driven investment approach with pre-defined levels of risk and return, not just levels, but types of risk and return, and a fixed term.

What they are not is quite interesting - I would not include with-profits which some people might categorise as a structured product, we would not include life settlements and we would not include covered call income funds. Nor would I call ETFs or passive funds structured.

We define our approach as structured investment rather than a structured product, the difference being we put research at the heart of the process. We think about where we should invest first and use derivatives to optimise the risk and return profile.

How do you see the products developing?

AT: We will definitely see a continuation of the tranche-based products, and I hope we will see more products driven from the investor need rather than the providers' sales objectives.

I am a bit wary of using the 'structured products' label because there is not a homogenous set of products that sit within it.

But if you have got a structured product that is linked to the FTSE, it has far more in common with other UK equity-type instruments, than with a structured product that may be a CPPI-type strategy, linked to commodities.

In which market environment are structured products best suited?

SG: The purpose of a structured product means they are tailored for different market environments.

If you are in a down market, there are products you can access that not only provide principal protection but provide an inverse exposure to a falling market and in rising markets, there are products which address that.

NC: People need to start moving away from thinking that structured products are their own little outlier in terms of the asset allocation model. They sit as a core part of the asset allocation model, whether you put them in the same bucket as the funds and ETFs.

AT: I think we could do with starting to think of structured products in terms of what the product actually is and what the risk/reward profile is, rather than just seeing everything as being labelled within this 'structured products' bucket.

Do you think structured products will ever get over the stigma attached to the scandal of precipice bonds?

AT: I think the precipice bond is one example of things from the past that we as an industry have burdened ourselves with. I do not think we should ever forget it, we have got to look at what happened, why, what went wrong and also what went right, and learn from it.

It raises the need for continued ongoing education and clarity and transparency in all our explanations of risks and all communications with advisors and investors.

CT: Yes, the structured investments industry is already past precipice bonds and actually it is rather a laboured point that is outdated and yesterday's news.

Given the market landscape, which types of structured products are expected to perform better, growth or income?

NC: I am not going to predict which will perform better. What I can tell you is in the current environment, at the beginning of the year, everybody was after income, they thought growth in the market was really not going to happen, deposit rates were down to negative yielding, effectively, in some cases, so everybody was requiring income.

We have seen a bit of a sea-change over the last few weeks, suddenly people are thinking, 'I want to be in these markets', so therefore we have seen a big shift into growth products, albeit with some potential protection.

AT: I think investors are looking for both income and growth. Then you have got to look at where the market is, what you can genuinely provide and be confident it is representing good value.

I think at the moment it is quite difficult to solve the income problem, certainly with any sort of guarantees attached to it. So growth is probably where I would expect to see things being for the next few months, simply because that is where the market allows you to build attractive product.