Structured products debate participants
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Executive summary
• Structured product providers are increasingly moving into the institutional space to provide solutions to very particular asset and liability management needs, but as yet there is no market consensus on what constitutes, and what does not constitute, a structured product
• Structured solutions can be used to manipulate and tailor the risk and return profile of an investment portfolio while also seeking to generate alpha
• The structured solutions market has traditionally suffered from a lack of transparency, and this is still a major sticking point for many institutional investors
• The hybrid nature of many structured products introduces risk factors such as correlation, which are difficult to price and manage
• The transparency issue comes down to fees and the breakdown of the underlying structure. Many institutional investors struggle to get a clear picture of these
• The complex nature of structured solutions makes it difficult for banks to be completely transparent when it comes to pricing |
JF, Euromoney: Let’s start by trying to put the structured products market as it relates to institutional investors in context. How can we define this, if at all, as a market today?
DL, Commerzbank: Structured products means different things to different types of investors, and I don’t yet see anything like a single market emerging in structured products for institutional investors. But I would say that structured products broadly can be split into the derivative pay-off part of the structure, which is perhaps the most significant and relevant for larger sophisticated institutional investors, who are really only interested in some kind of risk transformation or access to a particular asset class, and the wrapper, the legal container for the structured product. The wrapper may be more significant for smaller institutional investors that don’t have large operations departments to deal with their products. It can also be very significant for some types of institutional investors for regulatory purposes, and in fact we’re increasingly looking at using regulated funds as wrappers for certain types of structured products to ease some of the problems associated with valuation and best execution for certain types of institutional investors. The other purpose of structured products is to combine several risks in one product. But I think a sophisticated institutional investor would probably reject a simple product – such as an equity principal-protected note – on the grounds that it’s a combination of things that, taken together, aren’t necessarily interesting.
EW, Calyon: I completely concur with that. It is unrealistic to think that the global family of structured products is suddenly going to become one market that will function seamlessly. One area of differentiation is the type of profile the investor has. On the interest rate side, obviously our main client segment is institutional investors. But on the equity side you find more that it is the man on the street who will be looking at these products. If you asked someone on the street what they think about the 10-year, five-year spread in euro going forward, they’d look at you blankly. If you ask them if they think the Dow Jones is going to outperform the FTSE then they might have an opinion.
KP, Legal & General: If we’re talking about the genesis of structured products for institutional investors then I think this has been led by pension schemes and insurers realizing they had to do more in terms of their liability management. A lot of them have been forced to switch into bonds, so they have had to think about how they can make those types of investments work harder in terms of returns.
TBS, Barclays Global Investors: I think it is useful to put definitions in terms of what an institutional investor actually makes of the product. If I think about pension funds, they could look at a structured product as a part and parcel of an asset allocation strategy, that is, as a component, which is where a CDO [collateralized debt obligation] or recently the popular CPDO [constant proportion debt obligation] would fit in. Or, they might look at a structured product to alter the whole asset-liability mix, which is potentially a very ambitious undertaking.
KP, Legal & General: The correlation between asset classes is important. For some institutional investors, like insurers, some of those correlation products work very well. A good example is equity-linked swaptions for some UK insurers that have had guaranteed annuity options. There’s a good reason for using the structured product there, because they can see a clear reduction in capital for holding them, but it’s very much driven by the precise liability.
WN, Prudential M&G: That’s the point. I think it’s the use that matters, and trying to link all these things together is impossible, because you’ve got a whole different set of products being applied in different ways. Right now equity derivatives professionals are looking at fixed income on the basis there are still things that can be developed in fixed income that are already in use in the equity markets. At the same time you’ve got pension funds becoming more sophisticated and insurance companies having to be more efficient with their capital, and therefore making use of things that they wouldn’t have 10 years ago. So there is an incentive for the investment banks to become involved in a sensible and reasonably aggressive way. However, structured products develop in response to where the requirements are, not in a vacuum. So I think to link them together in a nice package is almost impossible.
NH, Watson Wyatt: Quite honestly, we find the definition of structured products difficult. We have a structured products team, and if you ask that team what they believe they do, they believe they advise on the execution of products where the counterparty is a bank.
EW, Calyon: If you ask a structured products group what their mandate is then they want it to be as wide as possible. If I were asked what the definition of a structured product is, I’d say it’s providing a product that’s not readily traded on the market, where it involves combining one or the other product together and building a package, which is not readily available through markets.