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Asia-PacificOctober 20 2011

Structured products revival in Asia

The fight for market share in the Asian High Net Worth Individual (HNWI) segment is fierce, as private banks and wealth management arms of major banks from Europe and the US position themselves for future growth.
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Structured products revival in Asia

Asia Pacific's population of High Net Worth Individuals (HNWI, defined as those with more than $1m available to invest with) grew by 9.7% to 3.3 million during 2010, overtaking Europe for the first time.

According to the 2011 Asia Pacific Wealth Report from Merrill Lynch Wealth Management, together with consulting group Capgemini, total HNWI wealth rose by 12.1% to $10,800bn, compared with $10,200bn in Europe.

The region now comes in second only to North America, though it has a heavier concentration of Ultra High Net Worth Individuals, defined as having $30m or more to invest. During 2010 the number of UHNWIs in Asia rose by 14.9% to 23,000.

It is against this background of rapid wealth accumulation that the major global banks are ramping up their derivatives offerings.

Many Asian HNWI investors are very active directly trading equities on their local stock markets, but nonetheless appetite for both structured products and Exchange Traded Funds (ETFs) is growing, giving easy access to overall themes such as China consumer demand, or more difficult to access trades such as baskets of precious metals.

Braver than Europe…

For structured products providers, the Lehman Brothers bankruptcy back in September 2008 is still having an impact on the market. Lehman notes were sold heavily across the region, and there is a much greater awareness of counterparty risk than in the boom years of 2006 or 2007.

But three years on from the Lehman collapse, the retail market is doing well, and is the focus of a big effort from both US and European banks.

Asian investors are generally much more willing to take risk than investors in Europe. Whereas in Germany or Switzerland the market over the past 12 months has been dominated by structures that pay a high coupon, and guarantee principal unless there is a big drop in equities (typically 50% or more), across Asia there is a more of a split between products with and without capital protection.

In common with Europe, investors have stayed closer to home in recent years, preferring regional stocks or indices that they are more familiar with. The rapid rate of economic growth across Asia compared with Europe or the US has also been an additional reason to favour the regional equities story, with economic growth in China forecast at about 9.5% for 2011.

When they do look for global exposure, in general Asian HNWI remain much more knowledgeable about US than European equities, and the big drop in US equities over the summer was seen as an opportunity to get back into the US market at depressed price levels.

The appreciation potential of the renminbi (RMB) has also been a favoured theme this year, with exposures in both equities and fixed income underlyings. Analysts expect that international pressure on China to allow its currency to appreciate, combined with rising local inflation,  will eventually have an impact, and that there is considerable upside on renminbi investments.

"We have seen strong interest in the regional growth story, particularly in the RMB," says Olivier Pacton, Managing Director, Head of Investment and Treasury for Asia at HSBC Private Bank in Hong Kong. "Asian HNW clients tend to be convinced about long-term RMB appreciation, and hence prefer to invest their converted RMB into yield enhancement products like RMB-denominated Equity Linked or Interest Rate Linked Structured Products. HNW clients have also been using Structured Products to gradually accumulate RMB at a more preferential rate than the spot rate."

…But getting cautious

While Asian clients have greater risk appetite than those in Europe, there has been greater interest in recent months in principal-protected ideas, linked to equities or interest rates, Mr Pacton notes. For the same reasons of high market volatility, he says clients are also examining hedging solutions using derivative instruments.

"As a result of the risk-off environment, client interest for commodities ideas has diminished except for gold," says Mr Pacton. "Gold has been regarded as a safe haven, and a good hedge for the sovereign crisis, and we have seen stronger interest from clients in accumulating gold using structured products."

Bankers generally report that, since the summer sell-off on global equity markets, sentiment has become weak and clients tend to be more cautious. Conventional structured equity investment has slowed down as interest has shifted more towards gold and FX, trying to take advantage of volatility on the FX markets. Baskets of precious metals and rare earth metals were popular in the first half of the year, but are in much less demand in the so-called risk-off environment.

"Investors prefer to stick to the markets that they are the most comfortable with, namely regional Asian names such as Hong Kong and Singapore listed stocks, as well as the US," says Victoria Ip, Asia Pacific Chief Investment Strategist at Merrill Lynch Global Wealth Management in Hong Kong. "The themes that generated the most interest and conviction among retail clients are high dividend yield and high quality, defensive sectors and companies with stable cash-flows and cheap valuations along with secular growth stories."

The focus on Asian bourses and the US is echoed by Gerard Berclaz, Head of Markets, Asia Pacific, at Julius Baer in Singapore. He says some clients sought to capitalise on the volatility in US markets by selling deep out of the money equity puts.

Ms Ip says the traded volumes in structured products have fallen substantially as investors prefer either cash equities or vanilla products. But investors are still ready to take some very short-term exposure, for instance on equity-linked notes. As for commodity-related products, demand has tapered off since the early part of the year, and there have been outflows in commodities and resource related funds this year.

For more cautious investors, The Twin Win has become one of the most popular structures over the past two years. In the European market there is usually an equities underlying, though commodities underlyings are popular in Asia. The Twin Win product generates a payoff in directionless markets, giving a 100% participation payoff generated by either an upward movement or a small downward movement. There is, however, a lower barrier, which if hit transforms the product to simply tracking the underlying. 

"In general, Asian High Net Worth investors do not buy capital protected products with low barriers, but prefer to potentially buy at a discount via selling out of the money puts," says Mr Berclaz. "Barrier products are mostly traded in the form of Twin Win products with commodities underlyings. Gold, oil and copper have been the most popular commodities underlyings this year, sold as Reverse Convertibles or Twin Wins."

He also sees some interest in capital protected products with a slight yield pickup above deposit rates. These are mainly deposit-like structures linked to low risk investment strategies. Since short-dated interest rates are very low, most clients would leverage such products.

New regulatory framework

In the ETFs space, banks have had success in 2011 selling trackers with a regional theme, or giving exposure to some of the smaller stockmarkets. For example, Deutsche Bank has 43 ETFs listed on the Singapore Stock Exchange, and two products launched this year are the db x-trackers MCSI AC Asia ex-Japan High Dividend Yield ETF, and the MSCI Philippines Investible Market ETF.

Payoffs based on stocks with high dividend yield have become increasingly popular in Europe in recent years, and this theme is now spreading to Asia. The stocks included in the High Dividend Yield ETF launched by Deutsche Bank must have a dividend yield that is at least 30% higher than the dividend yield of the MSCI AC Asia ex-Japan Index. The index underlying the ETF is calculated in US dollars by independent index provider MSCI Inc, to reassure investors about its integrity.

Certainly, both ETFs and structured products are becoming a more accepted part of overall portfolio allocations on the part of HNWIs, and tighter regulation is helping boost confidence after the Lehman debacle.

New legislation was passed by the Hong Kong government in May of this year, which broadened the definition of structured products and tightened up disclosure rules on offerings, under the supervision of the Securities and Futures Commission. The new law was in line with market expectations, though an unexpectedly short implementation period did lead to a scramble by banks to comply with the new rules for products that were just being launched.

The indications are that there will be growing opportunities for the bank providers to sell structured products to Asian investors in the coming years. But it is an expensive process, and providers will have to go through quiet periods such as the fourth quarter of 2011, though they hope that investors will look afresh at their allocations either in early January or after the Chinese New Year break, which begins on January 23.

According to the Merrill Lynch/Capgemini report, at present Asian HNWIs are most heavily invested in real estate, which at 27% is well above the global average of 19%. Their 26% allocation to equities is significantly lower than the global average of 33%. In 2010 the allocation to fixed income instruments rose slightly from 20% to 22% but was still well below the global average of 30%. Cash and deposit allocations remained unchanged at 22%.

The majority of Asian HNWI holdings remained in their home region in 2010, though the allocation fell to 57% from 64%. Looking ahead to 2012, Asia Pacific HNWIs are expected to be more heavily invested in equities and fixed income instruments than they are today, with those allocations forecast to increase to 31% and 26%, respectively.

The allocations to real estate and cash or deposits are expected to decline further, as HNWIs broaden their risk appetite, while also securing predictable cashflows. By 2012, Asia Pacific HNWIs are also expected to trim their exposure to North America, as they turn to the emerging markets of Latin America in search of higher returns.

But competition is fierce. JP Morgan is a well established provider of structured products across the region, with Goldman Sachs, BAML, Morgan Stanley and Citi also very active. And the Swiss, French, and UK banks are aggressively growing their efforts, including HSBC with its traditional retail and corporate banking presence across the region.

Firms are under pressure to maintain existing relationships, and offer customised solutions to their Ultra High Net Worth Individual clients. Specialised teams are being set up bringing together wealth management staff with local knowledge, and investment banking units, to create the full range of payoffs with global equities underlyings as well as FX and commodities plays.

Many wealth managers have less experience of the full range of sophisticated products than is the case in a highly developed market such as Switzerland, and many bank providers are finding it hard to keep up with the rapid growth in the client base.

Fierce competition could negatively impact profit margins. But for those banks who succeed in striking the right balance between local knowledge and sophisticated product ranges, the next five years are likely to provide plenty of growth opportunities, at a time when established structured product markets such as Germany are experiencing slow growth.

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