Structured products are one of the few business areas on which banks still have a positive outlook – and the Asian side of the market is the busiest of all. Natasha de Terán reports on developments in Asia.
Asia had “a fantastic year”, says Henry Pang, head of equities and derivatives for Asia, (excluding Japan) at BNP Paribas. “The bulk of activity was propelled by the wealth management sector, where there was strong demand for equity-based yield-enhancement and geared products.”
The correction in the local equity markets, which for a while looked as though it might bypass Asia, has had a negative impact on last year’s investments. This has resulted in a somewhat slower start to business this year. However, hope for the market is by no means subdued.
“The wealth creation effect in the region is such that there is a lot of cash floating around the local system to go into structured products and straightforward equity investments. My feeling is that now that valuations have come back to more rational levels, we will see interest grow,” says Mr Pang.
Equity products
What most providers believe, however, is that the product types will change. On the equity side, Mr Pang notes that in the past few years many local investors went into products that work well in rising markets, but less well in declining markets. “For instance, investors were keen to buy into products that included early termination features, accumulator products and daily range accrual range notes, often on a leveraged basis and sometimes also with embedded FX carry trades. When the Hang Seng index fell sharply earlier this year and currency cross rates moved, a lot of those products went under water,” he says.
Mr Pang says that investors are instead now much more receptive to principal protected products. While some of them are happy to ride out the downturn with their existing investments, others are turning to banks such as BNP to restructure the products. “Another notable development is that the negative bank-related news flow has led many investors to scale back and sometimes unwind the positions they have on with particular product providers,” he says.
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If all that means a continuing amount of business for the equity-based teams, Gilbert Tse, head of fixed income, currencies and commodities in China at Société Générale Corporate & Investment Banking, meanwhile observes that the increasing equity market volatility and recent downturn have encouraged retail investors to look at commodity-linked underlyings, most particularly products linked to baskets of commodity types, such as base or precious metals, energy or agricultural products. |
Turn of momentum
Peter Hu, managing director and head of investor solutions at Barclays Capital (BarCap) in Singapore, says: “The momentum has turned toward commodity-based products, and particularly toward index-tracking products offering Delta-1 exposure to the markets.”
To tap into that demand, BarCap launched a UCITS III fund, the Barclays Global Commodities Delta Fund in Singapore and Hong Kong. The fund is linked to the performance of the Jim Rogers’ Rogers International Commodity Index (RICI), and the bank is in the process of launching funds in both Singapore and Hong Kong using a sub-index of the RICI.
Another product that has attracted interest is the DB Platinum Agriculture Fund, which employs a rule-based asset allocation strategy between seven liquid soft commodity futures. Its objective is to deliver returns linked to the DB Agriculture Euro Index, which, in turn, is composed of seven of the most liquid and frequently traded soft commodities.
The fund is unique on two counts: first, it is purely futures-based; and second, it attempts to overcome the so-called contango effect of futures-based investment. When later dated prices are higher than near month ones, the market is regarded as being in contango and the reverse scenario is known as backwardation. When a market is in contango, the periodical rolling of futures contracts with a fixed term, which is often used in commodity index construction, can be detrimental to return potentials and even trigger losses.
Instead of defining fixed contracts terms and investing systematically into the next futures contract, Deutsche’s so-called Optimum Yield approach overcomes the contango effect by choosing from a variety of eligible futures contracts with different terms and searching for the most profitable time to roll out a spot contract into a future-dated contract. This maximises the rolling returns in backwardation markets and minimises the rolling losses in contango markets.
“Our Optimum Yield technology selects the futures contract with the highest positive (or least negative) roll yield, which typically results in enhanced returns by addressing the dynamic nature of the commodity forward curve,” says Sharon Loh, director at Deutsche Bank. “It provides investors with an opportunity to gain diversified exposure to the agricultural sector through futures and not through equity-linked agricultural companies, which means it is still well up in terms of performance despite the downturn in equity markets.”
Currency awareness
Investors are also becoming more aware of currency as a distinct asset class and exploring ways of accessing it, according to Udi Epstein, director, FX structuring at Deutsche Bank Singapore. “Apart from structures referencing single currency pairs, long baskets and long/short baskets, there is a great deal of interest in structures referencing rules-based FX indices,” she says.
Deutsche Bank has launched several such products, including DB Harvest, which provides investors with access to both G10 and emerging markets carry trades, and the DB Currency Returns index, which aims to capture returns generated by well-known currency trading strategies.
“More broadly, we are seeing the emergence of demand for a more diversified investment approach in Asia,” says Ms Epstein. Deutsche Bank is aiming to meet this demand with its recently launched DBMaTRIx, a platform that provides investors with access to returns of a diversified portfolio of global macro managers.
“Global macro managers trade multiple asset classes: FX, equities, bonds, rates and commodities,” says Ms Epstein. “As they are generally in highly liquid instruments and invest across multiple geographies, these funds allow for a flexible trading style that seems to deliver outperformance in sustained periods of market dislocation.”
The Chinese market
The Chinese market is one of the areas of greatest interest for product providers. At present, there are two major categories of retail products sold in China. The first is the qualified domestic institutional investor (QDII) products, which are foreign currency-denominated products that local investors can purchase subject to certain restrictions.
Mr Tse says that the QDII products have been modestly popular because they leave investors exposed to the renminbi/dollar risk. There has been stronger investor interest in quanto-structured investment products, he says. Investment banks such as Société Générale will work with domestic distribution partners on these products, developing so-called quanto swaps, which are combinations of foreign currency swaps and interest rate swaps and which have structured pay-offs indexed against offshore financial underlyings. “Because the pay-offs are based on a renminbi notional, investors are able to access offshore exposures without the currency risk inherent in the QDII products,” he says.
Institutional investors
On the institutional investor side, China still lags behind markets in Korea and Taiwan, particularly where FX risk management is concerned. Mr Tse says this is due as much to local regulations as it is to the lack of liquidity in the onshore markets. “Chinese corporates are mostly using FX forwards for FX risk management. They lag [behind] their neighbours in other FX derivatives on renminbi, because of the lack of onshore FX options markets,” he says.
Those with large offshore operations are able to use options on non-deliverable forwards (NDFs) and other options strategies; but here Mr Tse warns that there are arising accounting and tax issues that make the hedges somewhat imperfect. “We are quite optimistic that a few years down the road there will be a wider range of local currency hedging instruments available and we expect them to use the markets actively. But the regulator will probably open up the markets only very gradually,” he says.
Interest rate swaps
The onshore interest rate swap (IRS) renminbi market, meanwhile, is developing “quite well”, according to Mr Tse. But here, again, there is a problem for end-users. This is because the most liquid sector of the IRS market is linked to an index on the seven-day repo rate, but banks are still using People’s Bank of China (PBoC) deposit and lending benchmark rates for deposit taking and lending operations.
“Corporates and other hedgers are thus left with the basis risk between the two, making the hedges somewhat imperfect and, though those benchmarks may gradually converge with further opening up of the interest rate market, the development of this market is taking time,” says Mr Tse.
Instead, corporates are doing quanto swaps to hedge out their rate risk, buying swaps based on CNY notional, indexed to offshore underlyings such as constant maturity swap (CMS) spreads, says Mr Tse.
The situation in China is evolving by the day, providing ample opportunities for product providers. Oft ignored, but by no means the least of these relates to non-Chinese client activity. “Most of our large corporate clients in Europe and elsewhere have exposures to China, either directly or indirectly, and they too have to follow developments in China,” says Mr Tse. To cater to this interest, Société Générale has been conducting seminars in Paris to give large corporates a better understanding of how the domestic market works and is progressing.
