In the second part of an interview, Exane's head of UK & Ireland cross-asset investment solutions distribution, Jonathan Cohen, talks about how structured products can mitigate the impact of market corrections, the low yields provided by fixed income products and provide opportunistic trades to capitalise on ad hoc market trends.

According to Cohen, investors are "quite nervous" about equity indices trading at record levels and "whether they are going to keep surprising everyone by going up".

"Both uncertainties can be mitigated by using structured products that incorporate soft capital protection as well as features such as the twin-win, where the investor gains in both bullish and bearish markets as long as the underlying asset price doesn't reach a certain level, and the lookback, where the entry price on the underlying asset will be the lowest level reached over a certain period of time," says Cohen.

Another challenge product providers and investors are facing is the low yields currently on offer in the fixed income market. According to Cohen, it is possible to address this by applying leverage on a basket of quality bonds that still have a bit of 'juice' in them; "something we offer via leveraged tracker certificates on the investment grade subordinated bonds of European insurers for example".

Another solution for sophisticated investors, "although more risky", is to play the correlation risk of defaults by doing 'first-to-default' CLNs where the investor gets exposed to multiple credit risks, but takes a loss if one credit in the basket defaults.

Cohen believes there are other opportunities that "can only be materialised by using structured products". For example, according to Cohen, it is clear that oil has been trading within a tight range for a while due to the fight between Opec and the US shale oil industry.

"To take advantage of this trend, Exane Derivatives has designed short-term range accrual notes that will pay a coupon that is only earned on days when the price of the barrel remains within a specific price range," says Cohen. "By taking the risk of losing part or all of their capital if the price is outside this range at maturity, investors can get access to yields superior to 8% both in EUR and USD over a 12-month period."

With deposit rates close to zero and credit spreads near all-time lows investors remain focused on yield enhancing solutions, according to Cohen. "Autocall and phoenix type structures represent the bulk of the demand and we are regularly being challenged by investors to try and find new ways to provide decent yields without having to go up the risk curve too much," says Cohen.

The low interest rate environment has also made difficult to offer certain type of products, according to Cohen. "Fully capital protected structures have become nearly impossible to offer while the combination of low rates and tightening credit spreads has made the risk/reward profile of most credit linked notes unattractive," says Cohen, pointing that since early 2016 there has been a volatility decline to historically low levels making it increasingly difficult to offer decent yield structures as the premium investors earn for putting capital or the return at risk is less.

"As volatility is the main driver in pricings today, it means that regular-style kick-out products that used to yield 10% to 12% are now yielding 8%," says Cohen. "This means that to achieve double digit returns we are compelled to recommend structures that are either less defensive or linked to a basket of stocks rather than market indices, a switch not all investors are ready to make."

Protection remains in focus and Cohen thinks that there is clearly still interest for products that provide hard capital protection. "But the current interest rate environment is making it very difficult to come up with interesting products that offer full capital protection, particularly in euros," says Cohen. "The only way to make it work for investors today is to go for partial hard protection, possibly combined with features designed to lower the cost of optionality such as synthetic dividends and volatility control mechanisms."

According to Cohen, it is "psychologically hard" for most investors to give up 5 or 10% of capital protection to finance the optionality while "price lowering features add a layer of complexity which most distributors and advisors are not comfortable with".

"The demand for more defensive soft capital protected structures is on the rise," says Cohen. "With VIX close to its all-time low and major equity indices trading at all-time highs we are seeing investors becoming increasingly nervous, especially as the market outlook is even more uncertain in light of QE tapering talks. Two years ago we were seeing demand for soft protection barriers at the 70-75% level but now it is not rare for us to see requests at the 50%, even 45% level."

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