Don’t head for the hills

Barclays Capital’s Lisa Chaudhuri assesses how structured products have fared during the recent market volatility.

As markets react to a series of downbeat releases this month – the Fed not expecting to raise rates until 2013 and further concerns about the health of the eurozone to name just two – investors would be forgiven if they decided to board up their investment portfolios and hide their savings under the mattress until things quieten down. But instead of running for the hills, investors should note that there are some particularly appealing opportunities out there, and not only for the perma-bulls.

Starting with the most cautious of investors, the recent flight to safety has driven swap rates to record lows, which makes fully capital protected products particularly difficult to price. For wealth managers seeking to buy protection, the issue therefore is how they want to position portfolios in a highly volatile environment.

It may make sense to look at investments with a defined floor – i.e. no more than 10% of an initial investment can be lost at maturity regardless of how far the underlying index or equity has fallen. By taking on a pre-determined level of risk there is still opportunity to create an investment positioned for market rises.

However, for those wishing to position their portfolios defensively against further falls but can afford a greater level of potential loss, structured products in which the client is selling volatility can offer attractive returns at the moment, with lower strike levels on the relevant index. For example, an investor could receive a return of 8.25% locked in for each year of a five-year term so long as the FTSE did not fall below 3,000 on annual observation periods during the term.

Initial investment would also be reclaimed in full at maturity subject to the creditworthiness of the issuing bank and the market not closing below 3,000 (a level not seen since the mid-90s) on the final date of the investment.

This particular style of product may suit those who are looking for a defensive profile for their portfolios but can accept a level of loss should the market close below the barrier.

Bull investors seeking to capitalise on the market sell-off and expecting a rebound should be looking for enhanced beta exposure to the market. It would be possible to structure an investment linked to the FTSE 100 with more than 200% exposure to the performance of the index over a five-year term, albeit with no buffer in terms of capital preservation at maturity should the index close lower than the starting level. It does however provide an interesting alternative to the ETF space if investors want to position themselves for a strong market rebound.

There are also opportunities to be had on issuer’s secondary markets, with some investment managers looking for investments with strike levels around the 6,000 mark that will be trading at a large discount to par.

Finally, there are means to benefit from volatility directly, such as exchange traded notes of UCITS funds available with linkage to the volatility market itself.

Structured products are by no means the only way investment managers can position portfolios to take advantage of volatility, but they do offer the advantage of being able to tailor the risk-reward trade off within a single investment and are therefore worth consideration in these unpredictable times.