Institutional Structured Products 9 th May 2014
Institutional Structured Products9th May 2014
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
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Who are Catley Lakeman Securities?
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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− £3bn originated and executed since August 2008− £955mn originated and executed in financial year to July 2013
37%
8%6% Autocallable 37%
Synthetic 8%Income 6%
51%
32%
12%5%
Defined Return 51%
Option Hedging 32%
Market Participation 12%
Delta One 5%
Business Split By Product Type
(Data to Q4 2013)
Where CLS sits…
Client Discretionary Portfolios
Institutional Investor
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So it’s key to understand counterparty risk?
Source: Bloomberg, data as at 9-May-2014
What we really care about is how stable the bond spread is!
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100
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700
Cre
dit D
efau
lt Sw
ap (C
DS)
leve
ls [b
asis
poi
nts
over
LIB
OR
per
ann
um]
Credit Spreads since June-2008 - Trading Ranges
Series4
high
low
maximum 1360
current
How are Structured Products Put Together?
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FIRST STEPBuy Zero Coupon Bond from Bank
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§ First step: buy Zero Coupon Bond from bank, it sits as Senior Unsecured Debt on the bank’s mainBalance Sheet
§ Net Amount Remaining to Invest: 11.21p§ Note: the 11.21p could be spent on a guaranteed coupon stream, what would this be called?
→ A bank corporate bond
£15yr zero-couponBond/Swap
Cost: 88.79p
£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
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§ 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: 21.67p§ Note: all puts are expensive due to a skewed demand for downside protection in the derivative
marketsEG: how probable do the models think it is that the FTSE will be below 4000 points in 6 years time?→ 21% chance (as of May 2014, updated from original research piece ‘Structured Investments and Value’)
£15yr zero-couponBond/Swap
Cost: 88.79p
£1to invest
5 years
Sell 5yr EuropeanPut Option
on the FTSE Risk At 60%
Strike (‘Knock-In Put’)
Cost: 10.46p
ZCB now worth £1
Knock-In Put:
Has the FTSE fallen by more
than 40%?
SECOND STEPSell Knock-In Put
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§ 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: 20.17– 20.67p§ 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: 88.79p
£1to invest
5 years
Sell 5yr EuropeanPut Option
on the FTSE Risk At 60%
Strike (‘Knock-In Put’)
Cost: 10.46p
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
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UPSIDE PACKAGEAccelerators
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• HSBC 5.5 year Fixed Rate Bond§ Price of 1 FTSE call option today: 10.08p§ Therefore the investor can afford: 20.17/ 10.08p
→ 2.00 call options
20.17p left to spend
In other words: 200% 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: HSBC 603 US Accelerator 9 (167%)
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HSBC 603 US Accelerator (167%)
Strike: 31-Jan-2014
Counterparty: HSBC
Currency: USD Denominated
Underlying: S&P 500 (1782 points)
Maximum Term: 6 years
Platform: EIS (subject to CGT under current tax rules)
Upside: 167% 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 1069 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, webelieve this to result in a conservative estimation of cumulative performance. Source: Bloomberg, data to 08-May-14
80%
90%
100%
110%
120%
130%
140%
150%
160%
Feb-11 Sep-11 Mar-12 Oct-12 Apr-13 Nov-13
Cum
ulat
ive
Perf
orm
ance
US Equity "Defined Return Security" cumulative
S&P 500 PR
S&P 500 TR
(cumulative +58.01%)
(1) US Supertracker 2: bought 16-Feb-11
(2) sold US Supertracker 2 for 118.41 centsBought US Accelerator 5with 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 103.63 cents >> overall cumulative performance of +59.31% versus a passive S&P TR investment return of +48.39%
Where does it fit?
15Source: Bloomberg, Financial Express, data to 6-May-14
USD Denominated Performance (TR)
Bloomberg Ticker 3 month 1 month Since Launch
(3-Feb-2013) (4-Apr-2014) (22-Feb-2013)HSBC 476 US Supertracker Series 5
B92SVS9 12.67% -0.87% 36.78%
Legg Mason Funds US Equity LMUSEAA LN Equity 6.60% -1.43% 31.23%
JPMorgan American Investment Trust
JAM LN Equity 7.07% 0.61% 30.59%
UBS US Equity Investment Funds
UBSUEAA LN Equity 5.49% -1.15% 28.88%
Neptune Investment Funds US Opps
CFNUSAA LN Equity 1.45% -2.01% 27.81%
Schroder QEP US Core Fund SCHRAMA LN Equity 6.33% -0.19% 27.20%
ISHARES S&P 500 SACC LN Equity 7.21% -0.25% 26.71%JPM US Equity Income HLIEX US Equity 8.42% -0.24% 25.94%Threadneedle Investment Funds American Select
TDNASGA LN Equity 2.04% -2.84% 25.74%
S&P 500 SPX Index 7.68% 0.23% 25.65%Findlay Park American Fund FINDLPI ID 5.56% 0.00% 23.68%M&G Investment Funds American
MGAMDAA LN Equity 4.45% -1.46% 20.72%
Brown Advisory US Equity Growth Fund BRAUSEB ID Equity 1.66% -2.44% 16.70%
Upside Package: Synthetics
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UPSIDE PACKAGESynthetics
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• 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
22.18p 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 2.9%
HSBC 6y Fixed Rate Bond
*All pricing as at circa May-2014
Yield : circa 4.7%
Yield : circa 5.0%
Yield : circa 5.23%(Rolled-up version, accrued max6*5.58% 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 4090 points.
To what extent is the manager prepared to put capital at risk?Soft protection at maturity at 4090 points.
At what level should the upper barrier be?5.23% annual, accrued daily for every day the FTSE closes within the range of 4090 to 8864 points.
HSBC 6y FTSE Reverse Convertible
HSBC 6y FTSE Digital
HSBC 6y FTSE Range Accrual
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UPSIDE PACKAGESynthetics
This shows the evolution of a live trade:
HSBC 440 FTSE Daily Range Accrual (7.0%)
19*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
FTSE
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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
Cou
pon
Paym
ents
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
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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
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Mark-to-Market
Source: Bloomberg, data as at 8-May-14
75.00%
85.00%
95.00%
105.00%
115.00%
125.00%
135.00%
Nov-11 Feb-12 Jun-12 Sep-12 Dec-12 Apr-13 Jul-13 Oct-13 Jan-14 May-14
FTSE 100 Index Performance [Price]
HSBC 363 Performance
Total return of index = 135% (dividend reinvestment assumingNet of Corporate Tax rate 20%)
Sterling Interest Rates
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Sterling Interest RatesGrinding lower, 10% autocall coupon equates to 15% in 2007 (ceteris paribus)
Source: Bloomberg (08-May-2014)
5 year currently 2.04%
2 year currently 1.10%
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Swap
Rat
e (%
)
GBP Swap Rates
Upside Package: Autocalls
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UPSIDE PACKAGEAutocalls
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• 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
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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
Cap
ital P
rote
cted
Cap
ital L
oss
Autocall observation coupon of 16%
Autocall observation coupon of 8%
100%95%
90%85%
80% 75%
Autocall redeems at 100p
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Current Yields
Source: Data as at 08-May-14
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Defensive (5% dropper) Dual Autocall A+
issuer(FTSE / S&P) (simple per
annum)
High yield bond ETF (Bank of
America Merrill Lynch Global
High Yield BB-B)
FTSE 12 month Dividend Yield
UK Gov't bonds 2 year (£ Gilts)
2 year Sterling Swaps
High Grade credit (£ Non-Gilts AAA
3-5)
UK Gov't bonds 6 year (£ Gilts)
6 year Sterling Swaps
RWANDA 10 Year (6 ⅝ 05/02/23)
COSTA RICA 12 Year (COSTAR 4
⅜ 04/30/25 )
YIel
d %
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Eg: HSBC 260 FTSE Defensive Autocall (10%)
HSBC 260 FTSE Defensive Autocall (10%) EIS
Strike: 7-Oct-10Counterparty: HSBCCurrency: GBP DenominatedUnderlying: FTSE 100 (5662.13 points)Maximum Term: 6 yearsPlatform: 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
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-5
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20
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Oct-10 Feb-11 May-11 Aug-11 Dec-11 Mar-12 Jun-12 Sep-12
FTSE 100 Total ReturnHSBC 260 FTSE Defensive
Annualised 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 29
• 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
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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
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Appendix
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Full Intra Day Secondary Market Liquidity
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£15yr zero-couponBond/Swap
Cost: 88.79p
Sell 5yr EuropeanPut Option
on the FTSE Risk At 60%
Strike (‘Knock-In Put’)
Cost: 10.46p
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
34Source: Weekly average data, as at 01-Oct-13
0
1
2
3
4
5
6
7
Trad
ing
Volu
me
£ B
IL Current
1 month ago
1 year ago
Trading in the top ten traded UK stocks is 29% of FTSE 100 futures
volume
The Operational Process
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§ 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 andis 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 thiscommunication are for indicative purposes only. Catley Lakeman Securities makes no guarantee of its accuracy and completeness and is not responsible for errors oftransmission 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 publiclyavailable sources or proprietary data. The opinions in this document constitute the present judgment of Catley Lakeman Securities, which is subject to change withoutnotice.
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 ofinstitutional and professional customers and is not intended for the use of private customers. This document is not intended for distribution in the United States ofAmerica or to US persons. This document is intended to be distributed in its entirety. No consideration has been given to the particular investment objectives, financialsituation 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 CatleyLakeman LLP. Registered Office: One Eleven Edmund Street, Birmingham. B3 2HJ. Registration Number: OC336585
DISCLAIMER
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