Investors who have suffered at the hands of the recent bear market can be forgiven for being a little cautious, however, many are simply turning to structured products, says Delphine Simon.
The growing success of structured products owes much to the increased appetite for products that offer capital protection while also offering substantial potential gains in a transparent way.
In the medium or long term, a direct investment in equity markets is generally considered to offer the best return. However, it carries the most risk and many investors are still licking their wounds from the bursting of the equity bubble and the subsequent bear market. As a result, many remain reluctant to go long on equities. Instead, these investors are looking for substitutes to classical assets, which would allow them to generate revenues without increasing the overall risk of their portfolio.
In this context, Société Générale has created new investment structures, designed to match the investor’s own constraints (such as investment horizon and the level of capital guaranteed) and prevailing market conditions.
Structured products, composed of a protection component (the zero-coupon) and a risked component (the option) that will provide the performance, allow investors to benefit from the sensitivity of specific parameters – notably volatility – and offer exposure to asymmetrical payoffs in the holder’s favour.
Historical volatility
Since 1998, the implied volatility of most major indices has soared. As a consequence, SG has continued to innovate in order to provide its clients with new kinds of products – including SG’s Everest concept, followed by the Annapurna and Altiplano strategies. These short volatility products (so called Vega- products), offer a 100% guarantee of an investor’s capital at maturity – whether the market goes up or down – but at the same time enable investors to benefit from potential returns, as long as there is not a downturn in the equity market.
Since 2003, equity markets have started to rise again, while implied volatility has dropped to extremely low levels, despite a few peaks caused by geopolitical disturbances. These historically low volatility levels now allow us to structure interesting new payoff scenarios that would have been difficult to structure under earlier market conditions.
These products are long volatility products (so-called Vega+ products). When volatility increases during the investment period, the Vega+ concepts gain value on the secondary market.
Below are two examples of structured products from Société Générale that allow investors to take advantage of a bullish medium to long-term equity market. Amarante has proved very popular with retail and private banking customers, while Basalt has been a hit with institutional clients.
The Amarante strategy
Amarante is intended for investors who want to delegate management of their portfolio over the long term, without having to look at it on a daily basis. As visibility is limited in the medium and long term, it is often difficult for a manager to fulfil such a mandate.
As such, Amarante provides an alternative to traditional strategies. It offers the advantages of profile-orientated portfolio management without the need to select a priori a management profile and without any risk to the invested capital.
Amarante is available over investment horizons from six to eight years and comes in three management profiles (prudent, balanced and dynamic) that can be diversified according to the investor’s requirements or preferences, such as spread across equity, rates, property and alternative management products.
The purpose of this concept, which includes fully guaranteed capital, is to give investors 100% of the best protected performance of the best performing profile during the investment period (based upon annual observation).
The protected performance of each profile is defined as the average of the performances of said profile recorded at each observation date during the past period of investment.
The Basalt strategy
Basalt is designed for institutional investors who wish to take advantage of an expected upturn without the risks connected with market timing. Such investors want transparent solutions to replace direct investment in the equity market, allowing them to generate a performance without aggravating their overall portfolio risk.
Basalt is available for investment horizons ranging from six to 10 years and is underpinned by an evenly balanced portfolio of 20 international equities. Basalt enables investors to benefit from a market rebound at the right time and allows them to take advantage of the realised capital gain as soon as the initial target is reached.
The purpose of this concept, which again includes fully guaranteed capital, is to expose investors to the highest portfolio performance recorded at (generally) semi-annual intervals. It allows investors to recover their capital on maturity, plus it pays out the highest semi-annual performance recorded by the portfolio.
At the investor’s choice, the eight-year structure can be adjusted according to either of two variants if the highest semi-annual portfolio performance after four years is 40% or more.
Under the first variant, the product is repaid at the end of the fourth year and the invested capital is reimbursed together with the highest semi-annual performance recorded by the portfolio.
With the second variant, equity performance is converted into a bond performance. The investor converts the invested capital plus the highest semi-annual performance recorded by the portfolio into a bond investment with interest of about 8% a year.
For example, if the maximum semi-annual value reached by the portfolio is 150%, this 150% is invested in a bond offering 7%. In other words, the Basalt investment offers 10.5% interest a year on the initial investment during the last four years and repays 150% on maturity.
Delphine Simon is head of marketing, structured products
Relative benefits
Strengths of the Amarante structure:
- Because of the guarantee of invested capital, it is a very secure option
- Its multi-management structure means that the underlyings comprising each management profile are selected from a basket of asset manager
- It offers optimisation: investors have the guarantee that they will benefit, at maturity, from the best performing management profile; for example, the one best geared to market conditions during the period of investment
- The structure’s last strength is its transparency. Every year, the minimum payout guarantee at maturity is known, which helps to offset the impact of market corrections
Strengths of the Basalt structure:
- As with the Amarante strategy, the entire invested capital is guaranteed on maturity
- Performance is guaranteed to match 100% of the equity market, without limit or average
- Optimisation is geared to the length of the investment (with potential termination halfway to maturity)
- It is a transparent strategy: every six months, the minimum repayment to be expected on maturity is known
Additionally, a diversified portfolio and systematic application of the management process allow Amarante and Basalt to guarantee:
(i) A strategy designed to optimise market timing: both structures guarantee maximum portfolio value (with periodic observation). This protection is particularly welcome in the case of a market correction
(ii) A strategy that cannot be replicated by a traditional management style: Amarante and Basalt generate far less dispersed results than traditional management strategies. They combine the capture of most of the equity risk premium with controlled volatility.
