Shinhan Investment: traditional index-linked structures have lost traction

Since early 2013, proprietary indices have mushroomed in South Korea’s structured products market as the underlying of long/short equity-linked bonds (ELBs) recognised as great success in the local market. SRP spoke to Andy, IlWoo Lim, director and head trader in the equity swap department at Shinhan Investment, about pioneering in this segment and the opportunities prop indices offer to structured products investors.

Shinhan Investment is recognised for building proprietary indices around absolute return strategies. What is unique about Shinhan’s prop index offering?
There are a total of three proprietary indices developed by Shinhan Investment which all seek to generate market-neutral absolute returns – including Absolute Return Swap (ARS), Quad Global ARS 95 and Global Asset Allocation. ARS is based on a fundamental long short strategy which provides absolute returns without the influence from market performance. The two-year ARS linked ELBs matured in this month returned an annualized 31.7%. The accumulated volume of ARS linked ELBs launched by Shinhan Investment is at KRW1.7tr ($1.5bn), which accounts for 50% of the total long short ELB market.

The Quad Global ARS 95 was developed through leveraging our internal swap platform, which focuses on replicating a long short strategy using listed stocks in Korea, China and Japan. 75% of the fund are invested into listed stocks in Korea, China and Japan whereas the remaining 25% are invested into the US, Europe and other southeast Asian countries. For each investment decision, we would go through strict corporate analysis and perform various strategies such as event driven and arbitrage trading to seek for absolute return.

Similarly, the Quad Global ARS 95 linked equity-linked securities (ELSs) guarantees 95% of its principal and invests 400% of its net asset value with net exposure of ±30%. We maintain specific country and sector exposure to 20% and average net exposure at ±10%. Replicating the same strategy as the ARS, we invested $5m of our own fund in February 2014, and it is showing an accumulated return of 31.6% as of early December.

Lastly, the Global Asset Allocation index does not only replicate a long short strategy but invests in a variety of global hedge funds that implement global macro, arbitrage, event driven strategies. As it strictly controls the correlation of the asset classes and the beta, it allows the accumulation of rather stable returns even at times of global market stresses.

Can you tell us about Shinhan’s swap platform?
Shinhan Investment has built an internal swap platform to manage a long short portfolio using our internal fund which invests 150% of the net asset value of the total subscription amount. Most of the principal is invested into short term bonds to guarantee 2% of the annualised return which will be then added to the net asset value.

By balancing the interest earned and downside barriers through strict internal risk management, the ARS linked ELBs guarantee its principal at its maturity after two years from inception.

To minimize the impacts of market risk to the portfolio, we first place a limit of ±10% on the net exposure and we manage the sector exposure to avoid excessive concentration into a specific sector. We also restricted futures and options investment within the portfolio to maintain the target volatility of 8%. Furthermore, we first started investing 40% of the principal and then increase incrementally the allocation to the fund while the interest earnings accumulates as ways to better manage their risk.

Are there any new strategies in Shinhan’s pipeline?
We are planning to launch the Quad Global ARS 95 linked ELS in the form of a cross-selling arrangement, via strategic partnerships with global investment banks based in China, Japan and Europe. The first launch is expected to be in mid of 2015 and we expect the initial launch size to be around KRW300bn ($268m).

Due to its unique structure and stability, a lot of financial institutions from overseas showed great interest in our products. We are currently planning to expand our distribution channel out of the country and we are in discussions with foreign investment banks and asset managers to provide our products in return for distinguished strategies and financial products from overseas markets.

What are the key elements to explain the popularity of ELB and ELS among local investors?
Currently in the South Korea market, the long/short ELB and ELS market stands at KRW3.3tr ($2.9bn), while Korean themed hedge funds stand at KRW2.6tr ($2.3bn) with long/short public funds standing at KRW8tr ($7.1bn). As the low interest, low growth environment persists, there is a continuous demand for higher yield than the average deposit rate. Particularly, as the long short ELB guarantees the principal while its systematic risk management mechanism is acting as the key appealing point for local investors.

Do you think proprietary indices provide a better outcome than traditional indices in flat markets? Why are they being used so actively in the structured products space?
Proprietary indices allow retail investors to get access to various asset classes and strategies at lower cost through a more convenient way. [Previously] swap transactions were only available for the professional investors, [but now] we have included arbitrage, leverage and overseas asset classes to the index for retail investors. Furthermore, taking the advantage of their structuring flexibility using derivatives, the products can be structured in a variety of ways in the form of full principal protection, partial principal protection and leverage products.

How do you report the index performance and ensure the transparency of the indices? Do you also provide educational seminars for the individual investors?
The price of the indices are reflected through examination by two external evaluating agencies responsible for verification and calculation of the underlyings. We publish a daily report on our website, which includes the underlying level, net asset value, outstanding balance, transaction record and the cost for the investors to give a full picture about how the index performs. Also, we issue a performance report on a monthly basis to inform investors on how we are operating and implementing the strategies within the portfolio. Through constant communication with investors, accessibility and transparency have certainly improved to overcome some of the demerits of the propriety indices. Due to the complicated structure of some proprietary indices, we are also conducting information sessions and seminars on regular basis for financial institutions, corporates and high net worth individuals.

How do you see these indices evolving in the structured products market?
I believe that issuance of proprietary indices linked structured products will continue to grow in South Korea. In the current environment of low interest rates and low volatility, local investors are losing their appetite for investing in index-linked structured products. There is a growing demand for a diversified pool of structured products featuring a variety of asset classes and strategies.

Korean financial regulators are also supporting the development of proprietary index linked structured products. Also, as it has become easier for us to have exposure to overseas markets through close collaboration with global investment banks, we believe there will be more structured products featuring long/short strategies in the local market. Along with strong sales of long short ELB and ELS to the overseas market, the demand in overseas financial products will also increase among local investors fueled by the recent opening of the exchange-traded notes market which will further heat up the market appetite for proprietary indices.

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Shinhan Investment: traditional index-linked structures have lost traction