Recent events have shown that volatility and uncertainty are never far away in today’s investment world. Structured products are popular with both retail and institutional investors because of their diversity and ability to provide tailored solutions for many different market scenarios and investment goals.
Properties of structured products
In my view the three greatest properties that structured products possess are:
- Providing different degrees of capital protection
- The ability to generate yield or returns in flat or moderately falling markets
- Defining your outcomes and risk precisely
The rationale for structured products makes the most sense in volatile, uncertain or range-bound markets. A steady bull market is not generally a time when structured products are popular because they typically under-perform the market and most long only funds. It is also true that in bull markets investors quickly and conveniently forget about the need to worry about protecting their capital and so they often conclude (erroneously in my view) structured products have less merit at that time.
Since many structured products run for terms of five years or more it is possible to see several investment cycles during the lifetime of a single product. Once a product is "live" and has gone past its strike date, asset managers or financial advisers and the investors they represent rely on regular valuations in order to track product performance and prospects, just as they would automatically do for a fund holding.
The importance of valuations
Typically the issuing bank will provide daily, weekly or monthly valuations to the asset manager, these represent the "primary" valuations and can either indicate the level the position should be marked on the portfolio, or with a suitable bid-offer spread act as an indicative buy-back price. However many buy-side institutions that buy structured products will also seek to source independent valuations for either regulatory, accounting or best practice reasons to act as a "secondary" valuation.
Our company always see more questions from clients about valuations during times of volatility. Buy side firms and others want to understand what is causing any changes in valuation levels. They also seek to be assured that these valuations are accurate and take into account all market parameter changes which can vary significantly over short time frames.
It is also true that in such volatile periods “bid” valuations from investment banks are not always reflective of the true value of the product, or that bid-offer spreads widen significantly. Clients who have an independent source of valuations are better placed to identify such problems early because they have a way to challenge bank pricing.
It is self-evident that independent valuation services need to be accurate, timely and scalable to a client’s needs. But my experience has shown that what really makes such a service stand out is the reconciliation and support process to actually put those valuations to work. This is what a client looks for particularly in volatile times. One of my favourite comments from an experienced client of ours a few years ago (after having received valuations from our firm for some time) was that he had fundamentally improved his understanding of his portfolio of structured products as a result of the valuation process and the support and interaction he had with us.
It is the knowledge sharing and the opportunity to help the client get deep into their portfolio that is key, not just simply producing numbers. Asset managers and other buy-side firms are very busy operations managing a wide range of investments for their clients. Structured products are usually at the more complex end of the spectrum of the investments that they deal with and are often a relatively small part of a portfolio, so support from a specialist independent valuation provider is very important.
As well as being aware of how products are faring during times of volatility it is undeniable that imminent further regulation in different markets (such as MiFID II) will have a far reaching impact across the whole investment spectrum and I believe that the monitoring and analysis of structured products will need to be taken to the next level as a result.