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Capital Markets

US pension funds sell volatility via autocallables

Funds seek alternative methods to sell options.

Double-digit year-on-year falls in equity markets, super-high volatility and low interest rates are proving a big challenge for US pension funds struggling with short-funded deficits. But that volatility could be the key to making solid absolute returns using structured notes, say dealers.

Merrill Lynch in particular, fresh from surviving September’s cull of investment banks thanks to its merger with Bank of America, is busy marketing autocallables, a type of equity derivative product that can give high coupon payments if markets perform in certain ways.

"Many pension funds need to achieve a high rate of return, typically around 8.5%, which is difficult to achieve even in a bull market. It’s even more difficult to achieve in today’s market, with heightened volatility and low interest rates," says Mike Herarty, Merrill Lynch’s head of structured equity products. "We’ve been working with pension funds to design transactions that help them meet their investment objectives, and one of the more compelling of these is the autocallable, which takes advantage of current high levels of volatility to give investors the possibility of high returns while in many cases mitigating some downside risk."

Merrill says a typical autocallable transaction would be a five-year note linked to the S&P 500.

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