Structured products regain luster

Looks like there's a market for structured products... just in a different region!


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Structured products regain luster
Sam Riding

Monday, July 13, 2009

I came across something quite shocking the other day, when I took time out to consider the performance of sectors rather than individual funds.Take a moment to collect yourself.Are you ready? Here it goes. Structured products, the pariahs of Hong Kong investment industry for the last two years, and even as debate continues to rage over compensation for Lehman's minibond investors, have actually performed well. Of the 41 categories of funds sold in Hong Kong, Hedge/Structured Products is the third best performing over two years (to July , which pretty much covers the financial crisis and the minibonds saga. Along with Asia Pacific and Global fixed interest, and two currency fund sectors, it is also one of just five categories to have made money for investors over the period, albeit only 0.8 percent.Hedge/Structured Products is also the fifth best performing category over one year, seventh over three years, and 16th over five years.What happened to Lehman minibonds should not have discouraged Hongkongers from considering this type of investment. But this may be a big ask given the amount of noise that is still coming from the streets. At the very least the sector merits further analysis.There are 45 investments in the Financial Express Hedge/Structured Products sector, of which 26 have beaten the sector average. Although that average is a not particularly impressive 1.03 percent, it is notable that none of the top 26 funds have lost money over this period.

This result points to the key feature of most structured products, a capital guarantee.The top performing investment over two years is the Man AHL Guaranteed Futures fund, which has returned an impressive 21.9 percent over two years.According to Man, this fund aims for returns "with a low correlation to major asset classes, in particular stocks." It has succeeded in that aim, displaying very high alpha relative to the sector, at 10.85, and extremely strong defensive qualities with its beta of 0.25.The fund invests in a wide range of futures contracts, but more significantly it has a capital guarantee of 90 percent of the value of the initial investment. Man Investments also has the second best performing investment in the sector. Its AHL Diversified Futures fund having returned 15.32 percent over the two years.This fund has excellent qualities, with alpha of 9.38 and remarkable beta of -0.16. Remember, beta is a statistical estimate of how volatile a fund is in relation to its benchmark. The benchmark is assumed to have a beta of 1. On this basis, the defensive qualities of Man Diversified Futures are exemplary.However, before you start to consider Man as the saviour of the investment universe, bear in mind the company also has one of the worst performing funds in the Hedge/ Structured Products sector. Its Hedge Diversified fund has lost 43.14 percent over the last two years, with horrific negative alpha of -24.84. It ranks 47th out of the 48 funds in the sector.Returning to the top of the Hedge/ Structured Products pile, the third best performing fund is Schroder SS Market Performer, a guaranteed fund that has returned 15.01 percent over the period. Notably, this fund's underlying investment is in structured products.The fund has strong alpha of 7.33 and a beta at 0.48. It too has a capital guarantee, this time of 100 percent, but at the same time returns from the fund are capped at a maximum return of 20 percent. This is a reasonable trade off. Rounding out the top five performers are two funds from Hang Seng, one Hong Kong bank that has emerged relatively unscarred from the minibond meltdown. The fourth placed HS 106 percent CG China H Financials Lookback fund, an index linked vehicle with a capital guarantee of 106 percent of the sum invested, has returned 14.93 percent over the period. Meanwhile, the even more exhaustingly titled HS 100 percent CG Hong Kong Equity 13.5 percent 4.75 Years fund has returned 13.23 percent over the two years, while the Hang Seng Index has lost 14.85 percent.The 13.5 percent in the fund's title refers to guaranteed cash dividends it will pay to investors during the first four of its 4.75 year tenor. It has a relatively low participation rate, at 12.26 percent of any rise in the Hang Seng Index, but again, this is the price you pay for a genuine 100 percent capital guarantee.All of the top five funds in the Hedge/Structured Products have some complex characteristics, but understanding them is not that difficult, if you look hard enough, and if you ask the right questions.The minibonds fiasco was predicated on the nature of the particular investments involved, mixed in with a degree of ignorance, or lack of questioning, on the part of investors. It is time to move on and consider some of the benefits structured products can offer.

e-mail: btn2009@gmail.comall data provided by financial express

Quote :

Although that average is a not particularly impressive 1.03 percent,
it is notable that none of the top 26 funds have lost money over this
period.
This result points to the key feature of most structured products, a
capital guarantee

Accounting in the performance capital guaranteed structured product is cheating (I know I structured zillions of themm back to my young days)
Basically the client invests 100 in your product, you allocate in "risk free" assets enough to give you back 100 at the maturity (let's say 80) and the remainder (20) is invested in a highly leveraged structured derivative
(exotic options generally) that will boost the performance of the whole.
Basically the edge of the manager should be measured on the risky part and the whole product which at the end only gives back its capital guarantee needs to be compared with ... a basic saving account

Wow, Thanks for clarifying that.

Im not sure I totally understand the whole structured products division at ibanks. What exactly is this article saying then? the Author thinks that structured products will make a return in Asia? And according to you, structured products are no better than regular savings vehicles?

It would be nice to get a bit more insight in what structing does at ibanks.

cheers!

-snapman

Snapman wrote:

Wow, Thanks for clarifying that.

Im not sure I totally understand the whole structured products division at ibanks. What exactly is this article saying then? the Author thinks that structured products will make a return in Asia? And according to you, structured products are no better than regular savings vehicles?

It would be nice to get a bit more insight in what structing does at ibanks.

cheers!

-snapman

I was just reacting to the small part of the article I quoted regarding the capital guaranteed funds.
OK i was not clear and i'm detailing a bit more here my previous post

Well, let's structure together a 5Y capital guaranteed fund

Let's assume that :
- we are in a world where there are still rates and that 80 invested "risk free" (ie at LIBOR) compounded over 5 years give 100 (actually those figures were realistic a few years ago).
- the 5Y call option at the money on the S&P 500 worth 36. This option pays the 5Y performance of the S&P if positive, zero otherwise

My client invests 100 in the fund
- I deposit 80 at Libor (they will give me back 100 in 5Y)
- I purchase 50% of the call above for a price of 18
- my margin is 2

We have built a structured product that pays in 5Y 50% of the performance of the S&P 500 and is capital guaranteed (if the performance of the S&P is negative)

Let's assume there's a crash (again...) in 5Y, most of the funds and investments would likely be very negative while my fund returns a mere 0 that beats the sector... What a outstanding manager I am ! No ? Basically that's precisely what the quoted part of the article tells us...

Now on the saving thing. As you noticed 80% of our fund is invested in "risk-free" asset, the only speculative part being the 20% (oops 18% there's my margin!) of derivatives and the value of the manager is only on the "risky" part (and in our example, the manager doesn't need to manage anything). It would be equivalent for the client to invest 20 (i/o 100) and the manager to give him a return of -100% or x2, x3 etc and to measure this return.

I hope it clarifies, next time, the structured products in the IB and the return of the structured products.

This type of structuring is pretty much reminiscent of some hedge fund strategies I have seen when hedging different securities across different classes.

I always thought structuring in ibanking would be more mathematically heavy and require more modeling? How much math is needed for structuring?

I guess this also all depends on the clients needs and how complicated it may be ...

-snapman

Snapman wrote:

This type of structuring is pretty much reminiscent of some hedge fund strategies I have seen when hedging different securities across different classes.

I always thought structuring in ibanking would be more mathematically heavy and require more modeling? How much math is needed for structuring?

I guess this also all depends on the clients needs and how complicated it may be ...

-snapman

Actually the maths come in the derivative part. I took the example of a simple call but you'll typically find all kinds of exotic pay-offs. The business of the investment banks is pretty simple : they buy cheap and sell dearer. The difficult part with these complex derivatives is how much they cost, the price being the cost for the ib of the strategy to hedge the pay-off and that you know the actual price of the strategy only once it matured.

For example my pricing model gives me a price, I sell the derivatives at that price+my margin. At the end of the deal, if it appears that the actual price I paid to hedge this derivative is higher that the money I received from my sale, I make a loss... That's why the accuracy of the pricing model counts... And to illustrate, what happened with the complex structures during the crisis is the mathematicals model just didn't take into account properly the market conditions that occured. For some complex structured as CDO, no one on earth no what is the value, even with armies of quants working on the models.