Index provider Solactive has developed the Solactive High Dividend Maximum Upside Volatility Indices, a new index family designed specifically with structured products in mind. The starting objective is to create a portfolio of stocks exhibiting very high upside volatility and yielding a consistently high dividend yield, according to Timo Pfeiffer (pictured), head of research at Solactive.
"This index family would be particularly relevant for structured products payoffs with a short volatility profile, such as autocallables or discount certificates among others," said Pfeiffer. "Autocallables have a significant weight in the distribution and private banking markets. They are by far the most transacted and more attractive payoff structure in the current environment of low interest rates. A large number of those autocallables are linked to single individual stocks or some of the more well-known indices and they are used because they have a clear benefit around liquidity. However, we think there is a more efficient way by specifically tailoring assets for short volatility structures in general and autocallable products specifically."
The launch is a response to demand from structuring desks for underlyings that address volatility, according to Pfeiffer. "In the context of autocallable products structurers need a higher vol approach," said Pfeiffer. "There are many low vol high div underlyings out there which are used mainly for capital protected products where you get the upside exposure by buying a call option. Hence a low volatility approach helps to get a higher participation."
However, the approach of the new series "actually flips sides" as the objective is how to get a better coupon and /or more protection in the context of an autocallable, and in order to do that higher volatility helps, according to Pfeiffer.
"With this kind of underlying, outperformance is not the primary goal," said Pfeiffer, pointing that volatility should demonstrate a consistent pick-up versus the selected universe of the benchmark. "In addition, we have applied a dividend screening so that you also have stable dividend payments and also a pick-up at an index level versus the selected universe of the benchmark. We have also applied liquidity filters on top to make sure the index is tradeable which at the end of the day is what trading desks need to hedge their risk when issuing autocallable structures."
The new series have been launched alongside a research paper which provides a "detailed and technical" look 'under the hood' with a theoretical background and a description of the optimization process in detail. The research paper also shows how the methodology is applied step-by-step on the Solactive High Dividend Upside Volatility Euro 5% Adjusted Return Index, which is live and fully investible.
"The research paper is aimed at complementing our discussions with clients about the added value of a new index series in the context of autocallable products," said Pfeiffer. "We have launched a European and a US version, and we expect this approach will resonate with the wider market. The research paper incorporates feedback from clients which shows that there is demand for this kind of underlying."
Solactive is planning to apply this approach to other regions and markets, and is already working on developing an Asia version, according to Pfeiffer. "[We] are talking to a number of desks to fine tune the market/s, assets we will use to design it," he said.
The appeal of this kind of index for the end investor is that it provides better terms and potential higher returns, according to Pfeiffer. "Our calculations show that by using this kind of index, in a standard autocallable structure, the coupon could go up by about one and a half points," said Pfeiffer, adding that despite the firm's activity seems to be more visible in the exchange-traded funds (ETF) market it "remains very committed to the structured products market".
"Our activity in the ETF market seems to be more visible as those are all public but we work very closely with the structured products market and we will continue developing value-add underlyings for this market," said Pfeiffer.
Click in the link to access the Solactive research paper on customised indices for structured products.
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