Higher volatility and interest rates will lead to a rethink of structured products’ design as well as their role in portfolio construction, according to a panel of industry experts at the SRP Europe Conference 2023 hosted by Structured Retail Products (SRP).
The consensus in a March 8 panel discussion entitled ‘Global trends and investment opportunities in the current environment’ was that the industry must adjust to the new backdrop in financial markets. Meanwhile, innovative strategies in the ESG and thematics segments are fueling demand for new products, the panel said.
In the ten years through 2021, the main sources of premium extracted from structured products were, in this order, equity volatility, then credit, then rates, said Mohamed Hemissi, EMEA Head of Equity Payoff Structuring at J.P. Morgan.
“This obviously has changed massively in the past year,” he said. “Currently the mix would look more like interest rates first, then credit, and then equity volatility. “This is very important because it does change the way we design and we think about equity structured products. One consequence is that we need to think more about design and underlyings that do fit well in an environment of higher interest rates.”
Chris Taylor, Global Head of Structured Products at Tempo Structured Products, agreed and said markets have moved “from an environment where the economic backdrop was supportive of assets rising” to “exactly the opposite.”
“It was pretty easy to make money in the ten years coming out of the financial crisis,” said Taylor. “Most economists think it will be a lot more challenging in the years ahead. The consensus seems to be that we are in for a long-term period of potentially persistently lower returns. The unique selling points of structured products within that environment are really important.”
Those selling points include a structure’s ability to generate positive returns in adverse markets and to protect a portfolio from broader losses. They do, additionally, provide this without any fund management fees or need of skills, Taylor said.
“We need to go back to the drawing board,” added J.P. Morgan’s Hemissi. “We need to bring with us the toolbox of structured products. We need equity volatility, we need good research on the economy, good asset management, we need everything we learnt in the past 10 years about designing good indices, optimized indices. The game now is to beat inflation. The threshold of capital preservation is very high.”
“If we can highlight the benefits of structured products vis-à-vis active funds trying to deliver alpha, or passive funds only trying to deliver beta, then I think structured products have got a much greater role to play in portfolio construction in the years ahead,” said Taylor.
Clients looking for customization
Axel Lomholt, Chief Product Officer for Indices & Benchmarks at Qontigo, gave the index provider’s perspective. He said that clients are now much more involved in the design and marketing of the structured products and underlying indices than they were 20 years ago.
“We are seeing a significant take up in AUM in new, bespoke, customized indices and the issuance of new products,” he said. “All our clients are looking for more customization. Many of our clients are looking for a story,” he added, “and that leads to themes and thematics. A lot of what we focus on now is, what is the story that I want to tell? And what is the index that I can create to use as a reference within a structured product?”
The trend towards tailored solutions is playing to Qontigo’s strengths. An open architecture approach enables the company to work with leading data providers to develop new thematic and ESG offerings. While this is very different from years past, Lomholt stated that demand for established market-capitalization-weighted benchmarks including the EURO STOXX 50® and DAX® continue to do well.
As it happened, Qontigo’s STOXX took home the Best Index Provider award at the 20th SRP Europe 2023 anniversary edition awards that evening.
A more sophisticated indexing world
A second panel during the day counted on experts from index companies and allowed the audience to dive deeper into the complexities of index construction. Representatives from four firms including Qontigo highlighted that increasing innovation and sophistication are welcome and generally sought, as long as indices keep the principles of rules-based methodologies and transparency.
The panelists singled out two main areas where innovation is far and wide — ESG and thematics — often the two of them combined such as with clean energy and biodiversity. Increasingly, structured products clients are asking for a blend of strategies, targeted exposures, an ESG overlay, and a financial optimization such as a decrement or low volatility/high dividend filters, said Armelle Loeb, Head of Index Sales for EMEA at Qontigo.
Decrement strategies will remain a staple of the structured-product industry, the panelists said. The decrement mechanism helps issuers hedge dividend risk. It involves deducting a pre-determined amount in absolute or percentage terms from the underlying’s level or total return on a daily basis. By selling a structured product based on a total-return index with a decrement, the issuer is basically protected against dividend shortfalls. The investor, in turn, benefits from better pricing terms.
STOXX launched the first decrement index in 2014, Qontigo’s Loeb explained. “It took some time to educate the market and the regulators and to get to where we are today. It is extremely important that issuers and distributors have guidelines, rules, quality charters, because the decrement is a very powerful tool to optimize products and ultimately to deliver higher performance and/or offer protection for end investors.”
Sustainability thematics
Concluding the discussion about sustainability thematic investing, the participants described an increasing appetite in thematic indices for clean energy, biofuel, ocean care and sustainable development goals.
Erik Oscar Rotander, Head of Index Sales and Relationship Management for EMEA at Bloomberg Index Services, said that ESG investing is no longer simply about applying traditional exclusions and tilts. It is also about onboarding new and particular datasets, especially in the area of carbon and climate.
“Clients expect us to have the data and calculate the index, but also to be able to explain and articulate the narrative around the index,” said Rotander.
“There is demand from our clients to provide indices that will adapt themselves to a more challenging environment like inflation,” added Stephane Mattatia, Global Head of Derivatives Licensing and Thematic Indexes at MSCI. “And there is also the demand from clients and from the end investor to integrate big data, new technology and intraday measures within our indices. Ultimately, we do not want to do complexity for the sake of complexity” but be “always very clear on the objective of the index and the methodology.”
Overall, both panels provided an excellent opportunity to listen to a range of experts on the key drivers within the structured products market. The latest range of customized indices and innovative thematic and ESG strategies are proving fit for purpose to meet the demands of increasingly sophisticated investors.
