Reyker: structured products are not just autocalls

Structured notes are ideal for investors in the current environment as they provide sources of income and risk control. But diversifying the product offering is a must as hedging problems with autocalls could impact pricing.

As Reyker gears up to launch the Resilient Income fund, its first ever structured products fund, SRP spoke to Dr. James Chu (pictured). The company’s head of market and investments, about the revival of the fund wrapper as a vehicle to deliver structured products and a way to make them relevant to the intermediary market.

A number of funds of structured products have been launched in the UK market over the last few months. Is this an indication of a revival of the fund wrapper to deliver structured products?

Structured products as an asset class work very well, because of their defined payout and embedded risk management. Both are important to retail investors. I started in 96 / 97 doing structured products as funds, and the industry has evolved since then.

The market is presently dominated by plans, but there are investors that prefer to have a fund wrapper that fits in their compliance process. Many IFAs are also wary of the very long dated plans that are now in the market and want better liquidity. This has become more important following new regulatory requirements. After Mifid 2 came into force, many independent financial advisors [IFAs] see a tightening and more centralisation of their compliance process. Our structured product fund fits easily into the same framework that IFAs are using for most of their day to day activities.

Is Reyker moving away from plans using structured notes?

We see plans and funds complementary to each other. They are suitable for different types of investors. If you want a daily liquid solution, the fund will be an obvious choice. Reyker remains committed to both types of wrappers.

Can the Ucits brand help spell the myth that structured products are risky and complex?

Complexity does not equal risk. and I do not think structured products are overly complex. It is true that some of the risks involved in structured products are hidden. A worst-of strategy, for instance, takes on correlation risk. People think this is complex, because usually when you talk about correlation in a traditional portfolio context, you relate correlation with diversification and a reduction in portfolio volatility. But this is not the case with a worst-of strategy.

A lot of traditional products like investment trusts or asset-backed securities are also quite complex to understand and may contain hidden risks. However, they have been delivering good returns for investors for many years, as long as the people who invest in these assets know how these investments work. Many investors consider this asset class to be beneficial to their portfolios, but it is better to let the professionals manage them.

That is why we are saying structured product funds are complementary to plans. Some advisers are not afraid to use plans as they understand the products. Others are saying: let the professionals do the job. A professionally managed structured products fund fits the bill for these advisers and their clients.

How would you describe the competitive landscape in the UK structured products market? Do you expect growth/contraction in the market?

My understanding is that the structured notes market in the UK in 2018 was slower compared to 2017 [SRP data shows a decline in issuance (from 1,921 to 1,893 products), and sales (from £10.1 billion to £7.7 billion)]. A lot of it has to do with the market environment. Volume in structured notes has traditionally been relying on maturities and early maturities through autocalls. In Q3 and Q4 last year, because of the market correction, fewer autocalls [matured]. Brexit uncertainty may have been a factor too in investment decisions.

But I am cautiously optimistic about 2019. In the current environment, investors cannot just say ‘ because of the uncertainty, let’s keep everything in cash’. I don’t think interest rates are going to rise a lot in the UK, so you need to find new sources of income with good risk controls. Structured notes are ideal for investors in this environment Structured product providers in the UK need to stop worrying about each [others’] share of the cake. Instead. why don’t we work together to expand the size of the cake for structured products in the investment market in the UK. That is why Reyker is launching a structured product fund. I hope other providers have the same vision in expanding the structured products cake.

Are autocallable structures creating a bubble?

There was talk in the industry that some banks encountered hedging problem with autocalls. I don’t know how true that is, but let’s look at the effect of autocall issuance on the volatility term structure. During recent market falls, long dated volatility has not been reacting much while volatility at the short end has gone up. An explanation is that autocall hedgers are selling long dated volatility whenever they see short dated volatility spikes. Or, it may be that the market is expecting this to happen, capping any rise in long dated volatility.

If more banks encounter problems hedging autocalls, there will be an impact on pricing. From a structured notes or plan providers’ perspective, we have to make sure we diversify our product offering. Ultimately, we need to explain to the end-investors that structured products are not just autocalls. There are other good structured products. Phoenix, reverse convertible, growth products, structured deposits. Investors need to embrace these strategies. Again, the industry will benefit from working together to educate investors.

Could the use of risk control indices make structured funds more appealing to end investors?

The biggest challenge is to explain to the end investor how these indices work. A lot of our competitors and banks have been using these risk-control or fixed dividend discount indices. I always say be very careful. However, they may appeal to a certain type of investor. In that case, you have to make sure that you explain well enough to them how they work and the likely performance under different market conditions.

Can factors (smart beta) help structured products navigate the current market environment?

Some academics and quantitative research houses like Research Affiliates [are] challenging the rise of smart beta. Their logic is as follows: when everyone starts to invest in similar smart beta, the stocks in the indices become overpriced. Therefore, the potential for these smart beta indices to outperform becomes limited. You need to be contrarian in using smart beta, and look at the smart beta or factors that are the least popular. An example last year was the underperformance of value versus momentum.

Research Affiliates also show that for smart beta or factor investing, a portfolio of long/short strategies works better than a long only portfolio. Here is where structured products can help. Your portfolio only allows you to take long positions, but you could invest in a long/short strategy on smart beta factors that is packaged as a fund or a note. There are a lot of opportunities out there for banks. However, they need to be careful not to over-engineer these strategies that are hard to explain to the end investors.

Published by SRP
29 Jan 2019 by Pablo Conde