Great timing: How to issue products to best effect

In all active structured product markets there is a continuous issuance cycle from participating product providers, indeed the regular supply of new products is part of what makes a market defined as active.

Normal patterns

Many providers bring out similar product offerings in one tranche after another, typically 4-8 weeks apart depending on how long products are open for investment in any given market. The same product payoff and underlying asset combination often get repeated over the medium term with the precise product terms (such as yield or participation) fluctuating according to the pricing conditions at each launch date.

In the long term the popularity of different product types is driven by the terms that can be offered and investor demand and sentiment. However prior to each new launch date, providers are on the lookout for tactical solutions that can give them an edge over their competitors.

Different channels

Before looking at the various scenarios and mechanisms that providers employ we should consider the different channels that products are issued into. Retail markets whether sold through financial advisers or direct to investors has generally the biggest share of issuance, but also has the greatest compliance burden and processes for issuers, distributors and advisers which can inhibit tactical solutions somewhat. Private placements offer a better route for quicker solutions because the rules are lighter and there are less parties involved in the new product launch. Finally a “reverse enquiry” (an idea emanating from a professional client) or a product pitched at a single client such as a fund manager are the easiest routes to deploy such solutions though compliant issuance is still paramount.

Timing the underlying

Given that structured products are investment opportunities in one or more underlying assets it stands to reason that one tactical solution is good investment timing in the underlyings themselves, or a choice that may not have normally been considered. A fall in the level of an equity or index gives a chance to strike a product at a more favourable level if it is felt that the future prospects are good. It is generally shorter dated products linked to a single stock that this strategy makes the most sense as a short term change in the underlying prior to strike might be held to be the most significant. Similarly if a product provider takes the view that a stock is set for strong growth over a certain investment horizon then issuance before the market fully catches on to the same idea means that a tactical solution can be successful.

Longer dated index linked products do not give quite the same opportunity and arguably such types of products and the investors they attract should be about sensible long term tried and tested strategies.

Opportunities around pricing parameters

The second set of circumstances is around pricing parameters and how product terms change over time. A sudden increase in implied volatility makes capital at risk products such as auto-calls or reverse convertibles more attractive by increasing the yield that can be offered. If a provider feels that such an opportunity may be short lived it will be important to bring a product to market quickly. Increases in volatility often follow market falls or news shocks. While not usually so dramatic, increases in long term interest rates will also improve product terms and providers will also try to capitalise on such circumstances.

Issuance size

The other tactical considerations for providers is over size of issuance. Providers are always acutely aware of products that their competitors have issued either just before or will do just after an launch they bring to market. Such competitive offerings will likely have overlapping investment periods. Even if a provider is committed to a certain timescale (to make sure it has products always open from one tranche to the next for example) it will be aware of how the product will look compared to those open around it and try to gauge the amount of hedge that will be required, taking into account whether it feels that the product is likely to benefit or suffer from short term changes in product pricing.

Adding product features

A different tactic altogether is to issue a product with features that would directly benefit from market scenarios that a provider thinks may be likely. One of the most common of these is the “best entry” product, which sets its strike level as the lowest point of an initial period, perhaps three months of a six year product. This means that if there is a fall in the level of the underlying over this time the investor will not suffer because the product will automatically be set from the lowest level rather than emerge at the end of three months already with ground to make up if markets have fallen.

Such a solution does have a drawback, because the optionality that this feature gives will cost a significant amount which could otherwise have been used to generate extra yield or participation, and if markets do not fall in the first few months it will prove to have been wasted insurance. Products with features like this are seen from time to time during particularly uncertain periods.

Conclusion

In conclusion there are a number of tactical themes that a provider will always need to be aware of in order to keep its product line as competitive as possible.


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