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Institutional Structured Products February 2015. Agenda  Who are Catley Lakeman Securities?  What is a Structured Product?  Key Categories of Structured.

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Presentation on theme: "Institutional Structured Products February 2015. Agenda  Who are Catley Lakeman Securities?  What is a Structured Product?  Key Categories of Structured."— Presentation transcript:

1 Institutional Structured Products February 2015

2 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

3 Who are Catley Lakeman Securities? 3

4 4 What We Do Institutional 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)

5 Where CLS sits… Client Discretionary Portfolios Institutional Investor 5

6 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!

7 How are Structured Products Put Together? 7

8 FIRST STEP Buy 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 £1 5yr zero- coupon Bond/ Swap Cost: 91.15p £1 to 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 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’) £1 5yr zero- coupon Bond/ Swap Cost: 91.15p £1 to 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 STEP Sell Knock-In Put

10 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 £1 5yr zero- coupon Bond/ Swap Cost: 91.15p £1 to 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 STEP Choose Upside Package Option package Providing Economic Return Option package Providing Economic Return *so long as markets haven’t fallen by more than the put, ie 40% down

11 Upside Package: Accelerators 11

12 UPSIDE PACKAGE Accelerators 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 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

13 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

14 Performance of the US Accelerator Series 14 The 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

15 Upside Package: Synthetics 15

16 UPSIDE PACKAGE Synthetics 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

17 RESULTING STRUCTURE MANAGER CONSIDERATIONS & DECISIONS HOW 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 PACKAGE Synthetics This shows the evolution of a live trade:

18 HSBC 440 FTSE Daily Range Accrual (7.0%) 18 *Example structure first traded Oct-12 Traded example, semi-annual, HSBC 440 FTSE Income (3.5% s.a. Daily Range Accrual) Note

19 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 ( 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 ( to points) Downside (55% European Knock-In Put): if at maturity the FTSE has fallen by more than 45% of the initial level (below points), the structure will redeem paying the original capital minus 1% for every 1% the Index has fallen below the initial level

20 20 Mark-to-Market Source: Bloomberg, data as at 24-Feb-2015

21 Sterling Interest Rates 21 Sterling Interest Rates Grinding lower, 10% autocall coupon equates to 15% in 2007 (ceteris paribus) Source: Bloomberg (9-February-2015)

22 Upside Package: Autocalls 22

23 UPSIDE PACKAGE Autocalls 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

24 24 Payoff Example

25 25 Current Yields Source: Data as at 9-February-2015

26 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 ( 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% payoff Year 2: 100% barrier 120% payoff Year 3: 100% barrier 130% payoff Year 4: 95% barrier 140% payoff Year 5: 90% barrier 150% payoff Year 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 27 Mark-to-Market Structure outperformance to date: 9.77% Structure annualised volatility: 14.51% FTSE 100 annualised volatility: 19.93%

28 Source: A selection of popular UK funds, all rated AAA/AA by Citywire 28 Called in Year 2 (8 th October 2012), with the FTSE at 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 Situations16.70%19.92% Threadneedle UK Equity Income15.79%17.49% Underlying (FTSE 100)10.23%19.93% M&G Recovery11.14%22.56% Standard Life Investment GARS7.62%4.72% Jupiter Absolute Return4.51%5.51% Performance

29 Overview 29

30 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 Accelerators Supertrackers Call Spreads Usually participation in the form of an Accelerator, (but not always) Autocalls Defensive Autocalls Worst-Of Autocalls Synthetic Zeros Digitals Range Trades Range Accruals Reverse Convertibles Digitals Range Trades High Income Range Accruals Inflation Plus 30

31 Appendix 31

32 Full Intra Day Secondary Market Liquidity 32 £1 5yr zero- coupon Bond/ Swap Cost: 91.15p Sell 5yr European Put Option on the FTSE Risk At 60% Strike (‘Knock-In Put’) Cost: 13.0p Option package Providing Economic 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.

33 FTSE 100 Futures Daily Volume 33 Source: Weekly average data, as at 01-Oct-13 Trading in the top ten traded UK stocks is 29% of FTSE 100 futures volume

34 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 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.

35 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 Catley Lakeman Securities is the trading name of Catley Lakeman LLP. Registered Office: One Eleven Edmund Street, Birmingham. B3 2HJ. Registration Number: OC DISCLAIMER 35


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