Institutional Structured Products February 2015. Agenda Who are Catley Lakeman Securities? What is...
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Transcript of Institutional Structured Products February 2015. Agenda Who are Catley Lakeman Securities? What is...
Institutional Structured ProductsFebruary 2015
Agenda
Who are Catley Lakeman Securities?
What is a Structured Product?
Key Categories of Structured Product
Two case studies
Costs / Liquidity
How we support our clients
Appendix
2
Who are Catley Lakeman Securities?
3
4
Who are Catley Lakeman Securities?
What We DoInstitutional sales, structuring, pricing, execution, servicing for:− Defined return and market participation structured products− Delta one, ETFs, ETPs, trackers and structured UCITS− Research, analysis, portfolio manager training − Portfolio hedging, options modeling− Legal, tax and regulatory process advice
Highlights− Est. August 2008− Unparalleled experience− Exceptionally qualified team of eight− Leaders in institutional market for securitised product− Growing reputation for hedging advice and execution− £4.50bn originated and executed since August 2008− £550mn originated and executed in financial year (01/Aug) to February
2015− £217mn originated and executed in calendar year to date.
Business Split By Product Type (originated/placed last 6 months)
(Data to Q1 2015)
Defensive Au-tocall
Uncapped Participation
Access
Income
Capped Partic-ipation
Synthetic
Autocall Hedge
Three quarters of Defensive Autocalls were dual index
FTSE / ESTX
FTSE / S&P
RUSSELL 2000 INDEXEuro Stoxx 50 Pr
MSCI EM
FTSE 100 INDEX
MSCI EUROPE
x UK
S&P 500 INDEX
Where CLS sits…
Client Discretionary Portfolios
Institutional Investor
5
6
So it’s key to understand counterparty risk?
Source: Bloomberg, data as at 9-February-2015
What we really care about is how stable the bond spread is!
Royal
Bank o
f Can
ada
UBS
Rabob
ank
HSBC
Lloyd
s TSB
Barcla
ysRBS
ING
Credit
Suis
seBNP
JP M
orga
nBoA
Deutsc
he B
ank
Credit
Agr
icole
Comm
erzb
ank
Mor
gan S
tanley
Citigro
up
Soc G
en
Banco
San
tande
r
Goldm
an
Nomur
a
0
100
200
300
400
500
600
700
Credit Spreads since June-2008 - Trading Ranges
Cre
dit
Def
ault
Sw
ap (
CD
S)
leve
ls [
bas
is p
oin
ts o
ver
LIB
OR
per
an
nu
m]
high
low
maximum 1360
current
How are Structured Products Put Together?
7
FIRST STEPBuy Zero Coupon Bond from Bank
8
First step: buy Zero Coupon Bond from bank, it sits as Senior Unsecured Debt on the bank’s main
Balance Sheet
Net Amount Remaining to Invest: 8.85p
Note: the 8.85p could be spent on a guaranteed coupon stream, what would this be called?
→ A bank corporate bond
£15yr zero-couponBond/Swap
Cost: 91.15p
£1to invest
ZCB now worth £1*
5 years
*The ZCB is discounted at the respective interest swap rate for the term, plus the bank’s funding level, to return 100p at maturity
9
The next step is to sell a knock-in put on an index the investor is looking for exposure to
Net Amount Remaining to Invest: 21.85p
Note: all puts are expensive due to a skewed demand for downside protection in the derivative
markets
EG: how probable do the models think it is that the FTSE will be below 4000 points in 6 years time?
→ 21% chance (as of July 2014, updated from original research piece ‘Structured Investments and Value’)
£15yr zero-couponBond/Swap
Cost: 91.15p
£1to invest
5 years
Sell 5yr European
Put Option on the FTSE Risk At 60%
Strike (‘Knock-In Put’)
Cost: 13.0p
ZCB now worth £1
Knock-In Put:
Has the FTSE fallen by more
than 40%?
SECOND STEPSell Knock-In Put
10
The final step is to choose your upside package- for consistency we will stay with FTSE
Fee of 1 – 1.5%
Net Amount Remaining to spend on Upside Package: 20.35– 20.85p
Bullish? → Accelerator: geared participation in rising markets
Bearish? → Synthetic/ Autocall: both provide a positive return in flat to falling markets*
Somewhere in between? → Booster
£15yr zero-couponBond/Swap
Cost: 91.15p
£1to invest
5 years
Sell 5yr European
Put Option on the FTSE Risk At 60%
Strike (‘Knock-In Put’)
Cost: 13.0p
ZCB now worth £1
Knock-In Put:
Has the FTSE fallen by more
than 40%?
THIRD STEPChoose Upside Package
Option packageProvidingEconomic
Return
Option packageProvidingEconomic
Return
*so long as markets haven’t fallen by more than the put, ie 40% down
Upside Package: Accelerators
11
UPSIDE PACKAGEAccelerators
12
• HSBC 5.5 year Fixed Rate Bond Price of 1 FTSE call option today: 11.07p
Therefore the investor can afford: 20.35/ 11.07p
→ 1.83 call options
20.35p left to spend
In other words: 183% participation in the FTSE over 5 years
USE TYPE EXAMPLE SITS ALONGSIDE
Gearing / Participation Uncapped Accelerator / Supertracker Large cap / core long only funds and ETFs
How do Accelerators fit into portfolios?
These have been very popular this year, with clients bullish beginning of year view
Not usually held for more than 1 to 2 years
Eg: Credit Suisse 658 US Accelerator (179.5%) EIS
13
Credit Suisse 748 US Accelerator (170%) EIS
Strike: 30-Jan-2015
Counterparty: Credit Suisse
Currency: USD Denominated
Underlying: S&P 500 (strike 1994 points)
Maximum Term: 6 years
Platform: EIS (subject to CGT under current tax rules)
Upside: 170% participation (final year averaging)
Downside (60% European Knock-In Put):
if at maturity the S&P has fallen by more than 40% of the initial level (below 1196 points) at maturity, the structure will redeem paying the original capital minus 1% for every 1% the Index has fallen below the initial level
Performance of the US Accelerator Series
14The calculations above are based on gross reinvestment of proceeds. Average weighted entry/exit levels have been applied based on actual investor flows, we
believe this to result in a conservative estimation of cumulative performance. Source: Bloomberg, data to 8-Jan-2015
Feb-11 Sep-11 Mar-12 Oct-12 Apr-13 Nov-13 May-14 Dec-14
70%
90%
110%
130%
150%
170%
190%
US Equity "Defined Return Security" cumulative
S&P 500 PR
S&P 500 TR
Cu
mu
lati
ve
Pe
rfo
rma
nc
e
(cumulative +80.55%)
(1) US Supertracker 2: bought 16-Feb-11
(2) sold US Supertracker 2 for 118.41 centsBought US Accelerator 5 with proceeds reinvested @ 100 cents
(3) Sold US Accelerator 5 at bid price of 128.77cents >> Invested into US Accelerator 9 with proceeds reinvested @ 100 cents
Decision: How Bullish on US
Equities?
(4) US Accelerator 9 : current bid price of 118.41 cents >> overall cumulative performance of +80.55% versus a passive S&P TR invest-ment return of +64.29%
Upside Package: Synthetics
15
UPSIDE PACKAGESynthetics
16
• HSBC 5.5 year Fixed Rate Bond Guaranteed coupons: Reverse Convertible
Coupons contingent on an index being over a certain level: Digital
Coupon contingent on an index being between a range: Range Trade / Range Accrual
Note: all of the above can be structured to pay income
21.06p left to spend
How do Synthetics fit into portfolios?
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
USE TYPE EXAMPLE SITS ALONGSIDE
Yield Enhancement Defined Return Selling Volatilty
Synthetics Range Accrual ZDPs
RESULTING STRUCTUREMANAGER CONSIDERATIONS & DECISIONSHOW TO GET
HIGHER YIELD
Yield : circa 2.5%
HSBC 6y Fixed Rate Bond
*All pricing as at circa 9-February-2015
Yield : circa 4.67%
Yield : circa 5.25%
Yield : circa 5.67%
(Rolled-up version, accrued max
6*5.94% p.a.)
Put capital risk
Put coupon at risk
(via lower barrier)
Put coupon at risk
(add upper barrier)
Which underlying should the structure be linked to? FTSE
At what level should the lower barrier be?
Coupon paid annually as long as the FTSE is over 4,116 points.
To what extent is the manager prepared to put capital at risk?
Soft protection at maturity at 3,817 points.
At what level should the upper barrier be?
5.72% annual, accrued daily for every day the FTSE closes within
the range of 4,116 to 8,918 points.
HSBC 6y FTSE Reverse Convertible
HSBC 6y FTSE Digital
HSBC 6y FTSE Range Accrual
17
UPSIDE PACKAGESynthetics
This shows the evolution of a live trade:
HSBC 440 FTSE Daily Range Accrual (7.0%)
18*Example structure first traded Oct-12
3000
3500
4000
4500
5000
5500
6000
6500
7000
7500
8000
8500
+0 years +1 year +2 years +3 years +4 years +5 years +6 years
FT
SE
100
Upper Barrier: 7500 points
Strike: 5800 points
7% coupon paid as FTSE stayed
between barriers for whole year
1.75% coupon paid as FTSE exceeded theupper barrier for 75% of
the year
3% coupon paid as FTSE fell below the lower barrier for 50% of
the year
2.3% coupon paid as FTSE fell below thelower barrier for 33% of
the year
7% coupon paid as S&P 500 stayed
between barriers for whole year
7% coupon paid as FTSE stayed
between barriers for whole year
0%
2%
4%
6%
8%
+0 years +1 year +2 years +3 years +4 years +5 years +6 years
Co
up
on
P
aym
en
ts
Lower Barrier: 3500 points
Soft Protection at Maturity: 3500 points
Potential Coupon: 7%
HSBC Bond Coupon: 3.0%
Traded example, semi-annual, HSBC 440 FTSE Income (3.5% s.a. Daily Range Accrual) Note
19
Eg: HSBC 363 FTSE Daily Range Accrual (8.0%)
HSBC 363 FTSE Daily Range Accrual (8.0%)
Strike: 9-Jan-11
Counterparty: HSBC
Currency: GBP Denominated
Underlying: FTSE 100 (5460.38 points)
Maximum Term: 6 years
Platform: EIS (subject to CGT under current tax rules)
Upside:8% annual coupon accrued daily, for every day the FTSE closes between 55% and 150% of the initial level ( 3003.21 to 8190.57 points)
Downside (55% European Knock-In Put):
if at maturity the FTSE has fallen by more than 45% of the initial level (below 3003.21 points) , the structure will redeem paying the original capital minus 1% for every 1% the Index has fallen below the initial level
20
Mark-to-Market
Source: Bloomberg, data as at 24-Feb-2015
Nov-11 May-12 Nov-12 May-13 Nov-13 May-14 Nov-1475.00%
85.00%
95.00%
105.00%
115.00%
125.00%
135.00%
FTSE 100 Index Performance [Price]
HSBC 363 Performance
Total return of index = 40.44% (di-vidend reinvestment assuming Net of Corporate Tax rate 20%)
Sterling Interest Rates
21
Sterling Interest Rates
Grinding lower, 10% autocall coupon equates to 15% in 2007 (ceteris paribus)
Source: Bloomberg (9-February-2015)
No
v-0
7
Fe
b-0
8
Jun
-08
Oct
-08
Fe
b-0
9
Jun
-09
Oct
-09
Fe
b-1
0
Jun
-10
Oct
-10
Fe
b-1
1
Jun
-11
Oct
-11
Fe
b-1
2
Jun
-12
Oct
-12
Fe
b-1
3
Jun
-13
Se
p-1
3
Jan
-14
Ma
y-1
4
Se
p-1
4
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
2 year currently 0.965%
5 year currently 1.39%
GBP Swap Rates
Sw
ap
Ra
te (
%)
Upside Package: Autocalls
22
UPSIDE PACKAGEAutocalls
23
• HSBC 5.5 year Fixed Rate Bond Snowballing annual coupon which can redeem early if the index is over a certain level
These barriers typically fall each year
Note: Synthetics have a tenor of 6 years, Autocalls have an expected life of roughly 2 years.
→ Rates concern?
22.18p left to spend
How do Autocalls fit into portfolios?
Performance of Defensive Autocalls is predictable and defined
Bull market: Underperform
Bear market: Likely to outperform
Flattish market: Outperform significantly
USE TYPE EXAMPLE SITS ALONGSIDE
Yield Enhancement Defined Return Selling Volatilty
Autocalls Defensive Autocall Equity income finds and absolute return funds
24
Payoff Example
Level of Index 1st anniversary 2nd anniversary 3rd anniversary 4th anniversary 5th anniversary
100%
60%
0%
6th anniversary
Autocall observation coupon of 32%
Autocall observation coupon of 40%
Autocall observation coupon of 48%
Autocall observation coupon of 24%
Autocall continues to 2nd anniversary
Autocall continues to 3rd anniversary
Autocall continues to 4th anniversary
Autocall continues to 5th anniversary
Autocall continues to 6th anniversary
Capital protection barrier triggered
Ca
pit
al
Pro
tec
ted
Ca
pit
al
Lo
ss
Autocall observation coupon of 16%
Autocall observation coupon of 8%
100%95%
90%85%
80%75%
Autocall redeems at 100p
25
Current Yields
Source: Data as at 9-February-2015
0
1
2
3
4
5
6
7
8
9
10
YIe
ld %
26
Eg: HSBC 260 FTSE Defensive Autocall (10%)
HSBC 260 FTSE Defensive Autocall (10%) EIS
Strike: 7-Oct-10
Counterparty: HSBC
Currency: GBP Denominated
Underlying: FTSE 100 (5662.13 points)
Maximum Term: 6 years
Platform: EIS (subject to CGT under current tax rules)
Upside: Defensive autocall, 10% snowballing annual coupon
Autocall Barriers:
Year 1: 100% barrier 110% payoffYear 2: 100% barrier 120% payoffYear 3: 100% barrier 130% payoffYear 4: 95% barrier 140% payoffYear 5: 90% barrier 150% payoffYear 6: 85% barrier 160% payoff
Downside (50% American Knock-In Put):
should the structure not autocall on any of the 6 anniversaries, and the FTSE has fallen by more than 50% at any close over the life, the structure will redeem paying the original capital minus 1% for every 1% the Index had fallen below strike level
27
Oct-10 Feb-11 May-11 Aug-11 Dec-11 Mar-12 Jun-12 Sep-12
-15
-10
-5
0
5
10
15
20
25FTSE 100 Total Return
HSBC 260 FTSE DefensiveAnnualised Volatility over the life of the trade: HSBC 260: 14.51% FTSE 100: 19.93%
Outperformance over the Underlying: 9.77%
Total return of index = +10.23% (dividend reinvestment assuming Net of Corporate Tax rate 20%)
Mark-to-Market
Structure outperformance to date: 9.77%
Structure annualised volatility: 14.51%
FTSE 100 annualised volatility: 19.93%
Source: A selection of popular UK funds, all rated AAA/AA by Citywire 28
• 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
Period Range: 7-Oct-10 to 8-Oct-12
Total Return Performance 360 Day Volatility
Structure (HSBC 260 Def Ac) 20.00% 14.51%
BlackRock UK Special Situations 16.70% 19.92%
Threadneedle UK Equity Income 15.79% 17.49%
Underlying (FTSE 100) 10.23% 19.93%
M&G Recovery 11.14% 22.56%
Standard Life Investment GARS 7.62% 4.72%
Jupiter Absolute Return 4.51% 5.51%
Performance
Overview
29
Categories of Structured Products
CAPPED
UNCAPPED
ACCESS TO A PARTICULAR UNDERLYING
PARTICIPATION
SELLING VOLATILITY
DEFINED RETURN
YIELD ENHANCEMENT
AUTOCALLS
SYNTHETICS
INCOME Sit alongside: Income funds
Sit alongside: ZDPs
Sit alongside: Equity income funds and absolute return funds
Sit alongside: Large cap / core long only funds and ETFs
Sit alongside: Other vehicles accessing the same underlying asset
AcceleratorsSupertrackers Call Spreads
Usually participation in the form of an Accelerator, (but not always)
Autocalls Defensive Autocalls Worst-Of Autocalls
Synthetic ZerosDigitalsRange TradesRange Accruals
Reverse Convertibles DigitalsRange Trades High Income Range AccrualsInflation Plus
30
Appendix
31
Full Intra Day Secondary Market Liquidity
32
£15yr zero-couponBond/Swap
Cost: 91.15p
Sell 5yr European
Put Option on the FTSE Risk At 60%
Strike (‘Knock-In Put’)
Cost: 13.0p
Option packageProvidingEconomic
Return
Zero Coupon Bond
A notional swap from the
bank’s Treasury
Department
This is cancellable at any
point
They are ultimately
notional- do not need to be
sold, hedged or replaced.
Option Package
Calls and put options are,
logically, derivatives of
their underlying risk assets
Therefore, the options
market can only become
illiquid at some point after
the underlying market
becomes illiquid
Past Exceptions
Close Brothers & ELDerS- collateralised with British, Irish and some Icelandic banks and building
societies.
Retail Structured Product market.
FTSE 100 Futures Daily Volume
33Source: Weekly average data, as at 01-Oct-13
FTSE 100
Fut
ures
TOP T
EN TRADED U
K LIS
TED STO
CKS
VODAFO
NE GRO
UP PLC
LLO
YDS BANKIN
G G
ROUP P
LC
GLA
XOSM
ITHKLI
NE PL
BHP BIL
LITO
N PLC
RIO T
INTO
PLC
BRITIS
H AM
ERICAN T
OBACCO
DIAG
EO P
LC
ROYAL
DUTCH SHELL
PLC
HSBC HO
LDIN
GS P
LC
BARCLAYS P
LC
ROYAL
PLC
0
1
2
3
4
5
6
7
Current
1 month ago
1 year ago
Tra
din
g V
olu
me
£ B
IL
Trading in the top ten traded UK stocks is 29% of FTSE 100 futures
volume
The Operational Process
34
Investment Manager checks price with Catley Lakeman (via phone or Catley Lakeman website)
Investment Manager places dealing instruction to Dealer at Stockbroker
Dealer sends request to Catley Lakeman
Catley Lakeman sends email to Stockbroker Dealer and Bank Structured Products Desk with price
and notional
Dealer confirms
Bank confirms and executes
Note: Stockbroker faces the bank directly, they do not face Catley Lakeman.
Disclaimer
This is a marketing communication and has not been prepared in accordance with legal requirements designed to promote independence of investment research and
is not subject to any prohibition of dealing ahead of the dissemination of investment research.
The information in this document is derived from sources believed to be reliable but which have not been independently verified. Any prices included within this
communication are for indicative purposes only. 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 regulated by the Financial Conduct Authority. Firm FSA Reference No. 484826. Catley Lakeman Securities is the trading name of
Catley Lakeman LLP. Registered Office: One Eleven Edmund Street, Birmingham. B3 2HJ. Registration Number: OC336585
DISCLAIMER
35