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Institutional Structured Products

Institutional Structured Products. May 2013. Agenda. Catley Lakeman Securities Institutional Structured Investments Composition Institutional Structured Investments Examples – Accelerators / Supertrackers Institutional Structured Investments Examples – Range Accruals

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Institutional Structured Products

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  1. Institutional Structured Products May 2013

  2. Agenda • Catley Lakeman Securities • Institutional Structured Investments Composition • Institutional Structured Investments Examples – Accelerators / Supertrackers • Institutional Structured Investments Examples – Range Accruals • Institutional Structured Investments Examples – Defensive Autocalls • Why Use Structured Investments? • Appendix

  3. CATLEY LAKEMAN SECURITIES

  4. Catley Lakeman Securities • Founded July 2008 • Team of 9 • Combined investment sales experience –42 years • Combined structured investment trading experience –34 years • Combined structured investment specific experience –54 years

  5. Catley Lakeman Securities • FSA authorised securities and futures firm • Outsourced origination and distribution business, representing seven banks on a contractual basis • Sell and support (ie in both the primary and secondary markets) private placement securitised derivative investments to professional asset managers and institutions in the UK Source: Bloomberg, data as at 01-May13

  6. INSTITUTIONAL STRUCTURED INVESTMENT COMPOSITION

  7. WHAT ARE STRUCTURED PRODUCTS? • A structured product is a defined-return investment based on the performance of an underlying asset • Factors to determine at the outset: • Underlying asset – equity indices, commodities, interest rates, etc • Payoff – depends on your investment view, the risk/ return profile, income vs growth • Counterparty – mark-to-market considerations, diversification of issuers

  8. CAPITAL PROTECTED STRUCTURES 5 year in 2005 • Estimation of 170% Barclays 5 year FTSE Accelerator Bond (Traded 1-March-2005) • Matured at 117p (estimate) • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 74.61p • Aggregate Costs 1.49p • Amount to invest 23.9p Price of 1 call option atMarch 2005 14.06p Therefore with 23.9p, investor can buy 1.7x call options • →170% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash

  9. CAPITAL PROTECTED STRUCTURES 5 Year Today • Indication of the same 5 year capital protected participation structure today, with an AA- rated issuer • Hence why these structures are not traded today in the current pricing environment • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 91.79p • Aggregate Costs 1.49p • Amount to invest 6.72p Price of 1 call option today 9.70p Therefore with 6.72p, investor can buy 0.69x call options • →69% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash

  10. PARTIALLY CAPITAL PROTECTED STRUCTURES 5 year Today • Indication of a 5 year structure today with soft capital protection at 60%, with an AA- rated issuer • These structures can be a good alternative to passive or quasi-passive long only funds Option package Providing Economic Return • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 91.79p • Aggregate Costs 1.49p • Old amount to invest 6.72p • Sell put risk premium 14.93p • New Amount to invest 21.65p Price of 1 call option today 9.70p Therefore with 21.65p, investor can buy 2.23x call options • → 223% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’)

  11. PARTIALLY CAPITAL PROTECTED STRUCTURES 5 year in 2005 • How would this have looked in 2005? Estimation of a 5 year structure with soft capital protection at 60%, AA- rated issuer • These structures can be a good alternative to passive or quasi-passive long only funds Option package Providing Economic Return • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 73.79p • Aggregate Costs 1.49p • Old amount to invest 24.72p • Sell put risk premium 4.04p • New Amount to invest 28.76p Price of 1 call option atMarch 2005 14.60p Therefore with 28.76p, investor can buy 2.05x call options • → 205% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’)

  12. PARTIALLY CAPITAL PROTECTED STRUCTURES 6 year Today • How would this have looked in 2005? Estimation of a 6 year structure today with soft capital protection at 60% • These structures can be a good alternative to passive or quasi-passive long only funds Option package Providing Economic Return • Share Price at Issue 100.00p • ZCB / Swap inc. funding pickup 89.10p • Aggregate Costs 1.49p • Sell put risk premium 17.96p • Amount to invest 27.37p Price of 1 call option today 10.64p Therefore with 27.37p, investor can buy 2.58x call options • → 258% participation Option package Providing Economic Return GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Zero- coupon Bond/ Swap GBP1.00 Investor’s Cash Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’)

  13. INSTITUTIONAL STRUCTURED INVESTMENT CATEGORIES1. Accelerators / Supertrackers2. Range Accruals3. Defensive Autocalls

  14. CATEGORIES OF STRUCTURED INVESTMENTS

  15. INSTITUTIONAL STRUCTURED INVESTMENT CATEGORIES1. Accelerators / Supertrackers2. Range Accruals3. Defensive Autocalls

  16. Acclerators / Supertrackers • Seen by many as a cost-effective ETF replacement • Given 90% of respondents to the 2012 questionnaire were bullish, it is likely we will see more of these structures over the next year • Not usually held for more than 1 to 2 years

  17. Construction • HSBC 5.5 year Fixed Rate Bond • Yielding roughly 3.3% per annum at time of issue • Remove coupons • Present Value of coupon stream over 5.5 years: 17p • Left with an HSBC zero coupon bond worth 83p • Incorporate ‘soft protection’ • 60% soft protection on S&P 500 at maturity • Sell knock-in put: 12.5p • Incorporate upside • 100 – 83 + 12.5 = 29.5p to spend • 1 S&P call option is 16.5p; 29.5 / 16.5 = 1.79 call options HSBC 5.5 year Fixed Rate Bond Remove Coupons Incorporate ‘soft protection’ Incorporate upside All data as at time of issuance (Feb-11)

  18. Eg: HSBC 340 US Supertracker (179%)

  19. Mark-to-Market Source: Bloomberg, data to 1-May-13

  20. Performance • Since launch performance: 29.35% versus 18.20% sector average in the below list of funds Source: Bloomberg, Financial Express, data to 1-May-13

  21. INSTITUTIONAL STRUCTURED INVESTMENT CATEGORIES1. Accelerators / Supertrackers2. Range Accruals3. Defensive Autocalls

  22. Appendix:

  23. Range Accruals • 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

  24. Construction (‘Synthetics’) This slide shows the evolution of a live trade. MANAGER CONSIDERATIONS & DECISIONS HOW TO GET HIGHER YIELD RESULTING STRUCTURE HSBC 6y Fixed Rate Bond Yield : circa 3.00% 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 3500 points. Yield : circa 5.00% HSBC 6y FTSE Digital At what level should the lower barrier be? Coupon paid annually as long as the FTSE is over 3500 points. Put coupon at risk (via lower barrier) Yield : circa 6.85% At what level should the upper barrier be? 7% annual, accrued daily for every day the FTSE closes within the range of 3500 to 7500 points. HSBC 440 6y FTSE Range Accrual Put coupon at risk (add upper barrier) Yield : circa 7.00% Any additional considerations? In this instance the investors wanted semi-annual income, so the structure pas up to 3.5% semi-annually. *All pricing as at circa early Oct-12

  25. HSBC 6y FTSE Reverse Convertible (5.00%) *All pricing as at circa early Nov-12

  26. HSBC 6y FTSE Digital (6.85%) *All pricing as at circa early Nov-12

  27. HSBC 440 FTSE Daily Range Accrual (7.0%) *All pricing as at circa early Nov-12

  28. Eg: HSBC 363 FTSE Daily Range Accrual (8.0%) Source: Data as at 29-Jan-13

  29. Mark-to-Market Source: Bloomberg, data as at 01-May-13

  30. CS 425 FTSE Quarterly Range Income

  31. INSTITUTIONAL STRUCTURED INVESTMENT CATEGORIES1. Accelerators / Supertrackers2. Range Accruals3. Defensive Autocalls

  32. Defensive Autocalls • Performance of Defensive Autocallables is predictable and defined • Bull market: Underperform • Bear market: Likely to outperform • “Flattish” market: Outperform significantly • AutocallBacktest Analysis – illustrating where outperformance tends to occur

  33. Payoff Example

  34. Eg: HSBC 260 FTSE Defensive Autocall (10%)

  35. Payoff Unless the capital protection has previously been breached

  36. Mark-to-Market Structure outperformance to date: 9.77% Structure annualised volatility: 14.51% FTSE 100 annualised volatility: 19.93%

  37. 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

  38. COST AND LIQUIDITY

  39. Cost and Liquidity of Institutional Structured Investments • Cost/Fee structure of Institutional Structured Investments • Costs typically between 0.5% to 2.0% • How liquid are Institutional Structured Investments? • Can I buy and sell them? • Full Intra-day secondary market liquidity • Institutional structured investment s will price intra-day • Liquidity has existed on every single trading day for the entirety of the Institutional Market (i.e. over the last ten years, encompassing the Financial Crisis) • Liquidity exists at the level of the underlying they are referenced to. • For example, examine the liquidity of S&P 500 or FTSE 100 futures. • Consider for example volume traded on S&P 500 futures – current average for the last weeks trading is $128.4Bil per day * • *Source: JP Morgan Global Equity Derivatives & Delta One Strategy 6th May 2013

  40. WHY USE INSTITUTIONAL STRUCTURED INVESTMENTS?

  41. Why Use Institutional Structured Investments? • Why use Structured Investments in a portfolio? • They can be tailored to an investors’ specific requirements • They offer an investor access to a wide variety of underlyings (equities, indices, interest rates, inflation, commodities etc) • They can be structured via a variety of different outcomes at maturity, that are generally very simple to understand • They tend to do ‘exactly what it says on the tin’- both the returns and the risks are easily definable • As are the costs • They should be used as an active investment, which is facilitated by a liquid secondary market (they have proved to be almost the most liquid asset you can hold) that CLS services

  42. APPENDIX

  43. TYPES OF STRUCTURED INVESTMENTS 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

  44. TWO COMMON PAYOFFS Defensive Autocall • Defensive Autocall terms • HSBC • 6 year maximum term • GBP denominated • FTSE underlying • 8% annual snowballing coupon • 5% falling barriers • (100/ 95/ 90/ 85/ 80/ 75 as a • percentage of strike) • Soft protection at 60% at maturity • (European Knock-In Put) • Start Date: Investor invests 100p • Start Date + 1 year: Is FTSE above 100% Structure terminates and • of Start Level? pays back 108p • Start Date + 2 years: Is FTSE above 95% Structure terminates and • of Start Level? pays back 116p • Start Date + 3 years: Is FTSE above 90% Structure terminates and • of Start Level? pays back 124p • Start Date + 4 years: Is FTSE above 85% Structure terminates and • of Start Level? pays back 132p • Start Date + 5 years: Is FTSE above 80% Structure terminates and • of Start Level? pays back 140p • Start Date + 6 years: Is FTSE above 75% Structure terminates and • of Start Level? pays back 148p • Is FTSE above 60% Structure terminates and • of Start Level? pays back 100p • Structure terminates and investor loses 1% for • every 1% the FTSE has fallen from start to end date YES NO YES NO YES NO YES NO YES • Alternatives for higher yield • Move autocall barriers • Move soft protection level • Different Counterparty • Flat Autocalls • Worst- Ofs • Phoenix NO YES NO YES NO

  45. TWO COMMON PAYOFFS Range Trade • Range Trade terms • HSBC • 6 year term • GBP denominated • FTSE underlying • 8.5% paid out coupon • Range: 3500-7500 points, • annually observed • Soft protection at 3500 (60%) • at maturity • (European Knock-In Put) • Start Date: Investor invests 100p • Start Date + 1 year: Is FTSE between Investor receives 8.5p coupon • 3500 and 7500? Investor receives no coupon • Start Date + 2 years: Is FTSE between Investor receives 8.5p coupon • 3500 and 7500? Investor receives no coupon • Start Date + 3 years: Is FTSE between Investor receives 8.5p coupon • 3500 and 7500? Investor receives no coupon • Start Date + 4 years: Is FTSE between Investor receives 8.5p coupon • 3500 and 7500? Investor receives no coupon • Start Date + 5 years: Is FTSE between Investor receives 8.5p coupon • 3500 and 7500? Investor receives no coupon • Start Date + 6 years: Is FTSE between Investor receives 8.5p coupon • 3500 and 7500? Investor receives no coupon • Is FTSE above Structure terminates and pays • 3500 (60%)? 100p • Structure terminates and investor loses 1% for • every 1% the FTSE has fallen from start to end date YES NO YES NO YES YES YES YES YES NO NO NO NO NO • Alternatives for higher yield • Narrower range • Move soft protection level • Different Counterparty • Less yield • Memory feature • Range Accrual

  46. Appendix: Market Colour Data • Rates, Credit and Volatility • Sterling Interest Rates • Grinding lower, 10% autocall coupon equates to 15% in 2007 (ceteris paribus) • Source: Bloomberg (01-May-2013)

  47. Appendix: Market Colour Data • Rates, Credit and Volatility • Credit • Clients continue to chase quality • Source: Bloomberg (01-May-2013)

  48. Appendix: Market Colour Data • Rates, Credit and Volatility • Volatility in a bit more detail • Source: Catley Lakeman, JP Morgan Derivatives and Delta One Strategy, Bloomberg (01-May-2013)

  49. DISCLAIMER The information in this document is derived from sources believed to be reliable but which have not been independently verified. 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 a LLP registered in England and Wales, Registered Office : One Eleven Edmund Street, Birmingham, B3 2HJ. Registration Number: OC336585, FSA Reference: 484826

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