2008 firma national conference why you should know about structured products by : eric miller...
TRANSCRIPT
2008 FIRMA National Conference
Why You Should Know AboutStructured Products
By : Eric MillerManaging Director
Date: April 7, 2008
2
Contents
What Are Structured Products?
Industry Trends
Current Market for Structured Products
Looking Ahead: Emerging Themes for 2008
Challenges & Opportunities
Section 1
Section 2
Section 3
Section 4
Section 5
4
Structured Products Overview
Tools for Shaping Client Portfolios
What Are Structured Investment Products?– Structured investment products are investment vehicles which allow investors convenient and tailored
exposure to a specified reference asset.
– Both upside and downside exposure to the reference asset can be modified to suit investors’ investment preferences.
– About half of all structured products issued in the U.S. provide full downside protection for the invested amount, but partially protected and unprotected structures are gaining popularity.
– Most structured products can be cleared and settled via DTC or Euroclear.
Properly applied, structured products can be used to:
Selectively take on desired risk exposures while shedding undesired risks
Customize investments according to specific market views
Conveniently gain access to alternative investment classes that may be difficult to invest in directly
Eliminate or hedge specific portfolio risks or business risks
– Currency risk of foreign investment assets
– Inflation linked notes to hedge rising cost of liabilities for defined benefit pension plans
5
Structured Products Overview
Reference Assets – Many Choices
The return on a structured product investment can be linked to any major asset class. In addition to the most popular asset classes listed below, credit-linked and emerging market-linked products are gaining interest among more sophisticated investors.
EquitiesInterestRates
Foreign Exchange
HedgeFunds Commodities
S&P 500®
NASDAQ 100®
DJ Industrial Average®
Nikkei 225
DJ EuroStoxx 50
Hang Seng China Enterprises®
Stocks, ETFs & ADRs
3mo & 6mo LIBOR
10yr CMT
10yr – 2yr CMS
CPI
EUR (Euro)
JPY (Japan)
CNY (China)
GBP (UK)
BRL (Brazil)
Fund of Funds
Permal
MAN
Tremont
HFR Global Hedge Fund Index
Private Hedge Fund Portfolios
DJ-AIG Commodity Index®
GS Commodity Index®
Gold
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Structured Products Overview
Risk / Volatility
Cash Alternati
ve
Bond
AlternativeRet
urn
Cash Alternatives Short-term maturities (1 year or
less) principal protection Potential to exceed traditional
money market investment returns
Bond Alternatives Principal protection Potential to exceed current
fixed income yields
Equity Alternatives Structured equity solutions may
be customized to meet the specific market views and risk tolerance of investors
Potential to exceed equity market returns
Re-allocation exampleA principal protected equity linked note reduces the investment risk by incorporating principal protection, thus redefining the asset as a fixed-income alternative. By obtaining direct equity exposure in this manner it improves the risk adjusted performance of the overall portfolio.
Alternatives to Traditional Asset Allocation
Equity
Alternative
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Structured Products Overview
What are the building blocks of Structured Products?
The pricing components of an Index-linked Principal Protected Structured CD are:– A zero coupon bond
– An equity or index option
Zero Coupon Bond
Option
Principal Protected Structured
Product
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Structured Products Overview
Assume $100 is invested in a 5 year Principal Protected Structured Note, a 5-year interest rate of 5% and a face (or par) value of $100.
The current value of the zero coupon bond is $75. The zero coupon bond will accrete to a value of $100 in 5 year and guarantee the full repayment of principal. Thus, $75 is the current cost of providing the principal protection.
Difference of the $100 invested in the Structured Note and the $75 set aside for principal protection is $25. HSBC allocates $24 to an option linked to the underlying asset to provide the potential for an index linked return and if applicable, a minimum guaranteed return at maturity.
The remaining $1 is paid to Dealer. Investor’s return is based on the initial $100 investment, not $99.
$100
=
$75
+
$24
$1
+
What are the building blocks of Structured Products?
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Structured Products Issuance – US
The SPA reported a 78% increase in US structured
product issuance between 2006 & 2007
US Structured Products Volume – SPA Data
USD Billion
$28$32
$48
$64
$114
$0
$20
$40
$60
$80
$100
$120
2003 2004 2005 2006 2007
Source: Structured Products Association
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Structured Products Issuance – North America
Registered and unregistered notes, CDs and GICs
(excludes EIAs)
US/Canada Structured Products Volume – Arete Data
$5
$9
$17$19
$24
$34
$0
$5
$10
$15
$20
$25
$30
$35
$40
2005 2006 2007
Canada Issuance Volume US Issuance Volume
USD Billion*
Source: Arete Consulting*Canada issuance volumes converted to USD using respective end-year USD-CAD cross-rates
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Structured Products Issuance – Industry Comparison
Structured products issuance is now on par with other
forms of retail investment product
2007 New US Issuance Volume
$28$29
$34$36
$0
$5
$10
$15
$20
$25
$30
$35
$40
CEF EIA SP UIT
USD Billion
Sources: Arete Consulting, ICI (Investment Company Institute), First Trust Portfolios LP
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Industry Trends - Wrappers
The trend toward unlisted registered notes continues
CD issuance gained, despite a bull market in US and
international equities
US Structured Product Issuance Volume
Source: Arete Consulting
5%
22%
52%
21%
2005
2007
7%
16%
56%
21%CD
Registered Listed
Registered Unlisted
UnregisteredNote/MTN
$19 billion
$34 billion
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Market Trends - Underlyings
Non-equity products have gained market share
Interest rate and FX-linked structures have grown in
popularity over the past two years
US Structured Product Issuance Volume
Source: Arete Consulting
Equity
AlternativesCommodities
Real Estate
FX
Equity
Real Estate
FX
Commodities Alternatives
Interest rates
2005
2007
89%
80%
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Market Trends – Top Underlyings
US single index underlyings are consistently popular, but
a trend towards FX, commodities and global
index baskets is also evident
US Structured Products Issuance
Source: Arete Consulting
UnderlyingVolume
($M) UnderlyingVolume
($M) UnderlyingVolume
($M)
S&P500 BuyWrite 679 S&P500 3325 S&P500 3407
Sector Basket (ETF) 432 DJ Eurostoxx50, Nikkei225, S&P500 971 DJ Eurostoxx50, Nikkei225, S&P500 1381
Nikkei225 412 Nikkei225 746 Nikkei225 1004
S&P500 BuyWrite 354CNY, IDR, JPY, KRW, MYR, SGD, THB, TWD vs. USD
500 MSCI EAFE 905
DJ Industrial Average BuyWrite 212 Rogers Int'l Commodity Index 480 Apple 660
DJ Industrial Average 175 DJ Industrial Average 442 Constant Maturity Swap Rate 627
Nasdaq100 153 DJ Eurostoxx50 386 DJ Eurostoxx50 627
PHLX Housing Sector 127 Constant Maturity Swap Rate 385 Russell2000 523
DJ Eurostoxx50, Nikkei225, S&P500 118 DJ AIG Commodity 357 DJ Industrial Average 470
Russell2000 112 Apple 348 BRL, CNY, INR, RUB vs. USD 446
2005 2006 2007
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Market Trends – Principal Protection
Significant growth in reverse convertible volumes and a bull market in US equities
have driven down the market share of principal protected
structures
Distribution of US Deals by Capital Protection Level
Source: Arete Consulting
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007
<100% 100% >100%
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What a difference ayear makes
Current Market for Structured Products
Credit Crisis Challenges Investor Confidence– Investors initially enjoyed better structured product terms due to issuer funding difficulties
(Merrill Lynch, Lehman, Bear Stearns)
– Then, the unthinkable almost occurs: could one of the largest US commercial or investment banks fail?
– Bear Stearns bailed out by the Fed, JPM
Structured product investors now increasingly choosy about issuer credit quality
BankShare price YoY
% changeCDS
Mar 07CDS
Mar 08Citigroup -63% +16bps +237bpsUBS -57% +11bps +228bpsLehman Brothers -56% +45bps +443bpsMerrill Lynch -49% +38bps +326bpsBarclays -40% +9bps +174bpsJPMorgan -15% +22bps +167bpsHSBC -12% +10bps +155bpsSource: BloombergNB: CDS spreads and USD share prices from 15 March 07 and 17 March 08
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Current Market for Structured Products
Stock Market Volatility Up
VIX Index – 5 Years, Weekly Data
Stock Market Performance Down
S&P 500 – 1 Year, Daily Data
Investors are uncertain as to the direction of the stock
market in the short to intermediate term.
Source: Bloomberg
20
Even Apple Inc. stocktakes a dive
Current Market for Structured Products
Reverse Convertibles Perform Poorly– More reverse convertibles are returning stock
– Sales volumes begin to plateau in 2nd half of 2007
– Apple Inc. falls 40% from peak to trough in past 3 months
Apple Inc. – 6 Months, Daily Stock Price
Source: Bloomberg
21
Brokers and advisors are looking beyond Reverse
Convertibles
Current Market for Structured Products
Searching for Safety– Increased demand for principal protection especially via CDs as FDIC insurance comforts
credit fears
– Partial protection OK as long as protection is “firm”, not “contingent”
Performance Through Uncertain or “Sideways” Equity Markets– Absolute return notes for equity cash on the sidelines
– Accelerated return notes: more bang for the buck
Quest for Yield Continues– Autocallable notes gaining popularity beyond Latam and Private Banking marketplace
– Return of the LIBOR range accrual note
23
The asset management industry continues to evolve
Emerging Themes for 2008 - Convergence
New Wrappers for Structured Investments– Mutual funds and Unit Investment Trusts (UITs) offering principal protection
– Closed-end funds offering buy/write yield enhancement strategies
Active Management Offered via ETFs– Recent regulatory approval for the first actively-managed ETFs
– Formerly the territory of mutual funds and SMAs
New “Strategy-based” Indices– Replicating active management techniques for structured notes
– S&P’s DTI and CTI indices (HSBC)
– SEVENS Index (UBS, MS)
– Citibank Country Selection Index (Citi)
– Adagio Index (Bear Stearns)
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As interest rates fall and the bull market in equities fades, investors look elsewhere for
returns – often in hard-to-access investment areas
Emerging Themes for 2008 – Access via Structured Products
Market Volatility Encourages Search for Uncorrelated Investments– Hedge funds still inaccessible to many retail investors
– Advisors more willing to consider other (non-equity) asset classes
Investors Round Out Equity Portfolios– Emerging markets: have these economies de-coupled from G7?
– Access to “Frontier” markets
Customized Indices Provide Access to Sectors & Themes– Increasing development of new indices by Issuers in conjunction with S&P and Dow Jones
– Daily pricing via Bloomberg/Reuters and independent calculation agent instill investor confidence
Asset Class 2007 YTD 2008 YTDInterest Rate $814 $1,822FX $567 $2,155Commodity $748 $3,001
Notional USD millions
Source: Prospect NewsNB: YTD data through March 24 of each year
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Today’s challenges will lead to new opportunities and
encourage continued innovation
Today’s Challenges...
Credit Crisis– Avoid the taint of problems in the structured credit market (SIVs, CDOs, etc)
– Restore confidence in the credit-worthiness of Issuers
Taxation of ETNs– Aggressive marketing of ETNs has led to increased scrutiny
– Clearer guidance as to tax treatment of certain structured products may benefit industry
Poor Performance of Reverse Convertibles– Independent broker-dealer channel most vulnerable
Current Market Environment Unfriendly for New Equity-linked PPNs– Low interest rates, high equity volatility
– Opportunity for more interest-rate and FX linked principal protected notes/CDs
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Today’s challenges will lead to new opportunities and
encourage continued innovation
...and Tomorrow’s Opportunities
Get the Word Out!– Increased broker awareness of structured products through education
– Nearly ¾ of structured product volume in 2007 sold via Issuers with internal distribution channels1
Great Time for Structured Products to Shine– The current market environment highlights the many benefits of structured products:
1. Attractive combinations of risk and reward
2. Access to uncorrelated asset classes and hard-to-reach markets
3. Returns linked to customized and/or strategy-based indices
1Source: Structured Products Association