Kempen has launched two capital protected Index Guarantee Notes (IGN's) linked to a dynamic risk control strategy in the Netherlands. VL Risk Controlled IGN Eurozone 16-24 and VL Risk Controlled IGN USA 16-24 were introduced via trading at Euronext Amsterdam on March 21 and are linked to the Eurostoxx 50 and S&P 500, respectively.
SRP caught up with Laurent Guntenaar (pictured), director, structured investments at Kempen, who gave us the lowdown on the risk control strategy.
"Instead of manufacturing a capital protected product on an index, we have now used a strategy," says Guntenaar. The strategy invests in a combination of the so-called risky asset, in this case an index, and the cash component, the risk-free asset, which is similar to a constant proportion portfolio insurance (CPPI), according to Guntenaar. "[The strategy] is a vol-control strategy. Volatility is quite high at the moment, and has been high for a long time, because of the macro economy, the geo-political tensions and the general market turmoil. That coupled with low interest rates means it is virtually impossible to create products with 100% capital protection at the moment," he says.
"We have still opted for an index as underlying, albeit an index with a full-control strategy overlay where we control the volatility. That is, if the volatility is higher than the target volatility then a larger portion is invested in cash so that we end up back at the level of the target volatility."
When comparing the volatility of the Eurostoxx 50 with the S&P500 you see that the S&P is less volatile, according to Guntenaar. "There is at least three points between them and on top of that the S&P is in dollars so you have more money to spend on optionality," he says. "The target volatility we use for the Eurostoxx 50 is 10%, compared to 14% for the S&P. You have to keep the Eurostoxx volatility artificially lower than the S&P to be able to offer a decent participation. In other words, you can set a higher target volatility for the S&P and still you will get a higher participation."
A criticism of the first generation of CPPI's was that they could cash-out at any time, causing the product to unwind with investors receiving the remaining value, however, for later versions (2.0 CPPI), this is no longer the case, according to Guntenaar. "In that case you have a minimum allocation in the risky assets at all times and [with the Risk Controlled IGN] it is slightly different too," he says. "We could be for almost 100% in cash but you will 'never' see that because the formula we use (exposure is: target volatility divided by realised volatility) you will always remain in risky assets and can increase again."
The Risk Controlled Eurozone IGN is denominated in euros while the Risk Controlled USA IGN is issued in dollars and you can clearly see the difference, says Guntenaar. "There are two things to look out for. First there is the participation rate which is 100% for the euro-version. That means you participate 100% in the strategy - the combination of the index and the cash component - and not in the index itself. For the dollar-version the participation rate, at 150%, is even higher."
What is also important according to Guntenaar is the initial weight of the risky-asset. "For the euro-version this is 40%. If this was a traditional IGN you would participate for 40% from day one, and that would remain the same for the eight-year term," he says. The participation in the risk controlled index is dynamic, other than in a traditional IGN where the participation is static, and Guntenaar thinks that is where the advantage lies: "If you issue an eight-year IGN on the Eurostoxx 50, you would have a 40% participation, for the entire investment period. For the risk-controlled version, the initial weight towards risky-assets - which is comparable to the participation rate - is also 40% but at any given time this can be lower or higher, and of course you hope for the latter," he says. "More importantly you want to be in cash when markets get volatile and surge while you want to be invested in equity when markets go up again. This will give you a chance to outperform."
Although the products are fairly complex, Kempen has chosen to introduce the IGN's via trading rather than having a subscription period. "There are a number of reasons," says Guntenaar. "A practical reason is that if you have too many products with a subscription period there is a chance that you overload the sales network, the advisers," he says. Kempen has been working hard on educating Van Lanschot's private bankers about this type of product for over a year, says Guntenaar. "Instead of having to explain a product within a week, we started much earlier, by doing presentations, explanation sessions, etcetera."
Normally you would expect when you launch a new product that you want as many investors to subscribe as possible and collect a high sales volume, according to Guntenaar. "Of course, that's what we would like in this case too, but for this product, especially because it is slightly more complicated, the expectation is that it won't be widely used, but more targeted on where and when the demand is instead," he says.
"There is still a demand for products which can be used as an alternative to a bond," says Guntenaar. "Due to the low interest rates and the high volatility it is no longer possible to offer this via a standard IGN. So that's why we have launched this product," he says. "We see this product much more as a product that you can have on the shelf and deploy when needed.
"Our advisers always have a need for bonds and especially in that part of the portfolio it is difficult to find alternatives. This is a product which can be used throughout the year."
Instead of equities, Kempen is hoping to also use the risk control strategy on funds in the not too distant future, according to Guntenaar. "We have already issued a number of products, not public offers but private placements, mainly on mixed-funds," he says. "These are funds which include stocks and bonds and cash and where the target volatility, because of the work of the fund manager, is lower than an equity index," he says. "But if you want a pure equity fund - European equities or global equities - without any other asset-classes, then the volatility of that fund is more or less the same as that of the benchmark equity indices. The idea is that we are going to use the risk-controlled versions on (pure equity) funds also for IGNs.
"It is something different," says Guntenaar. "Of course, initially we also received a response like, this is a complex product - and maybe it is - but if you compare it with for example a mixed fund, [mixed funds] also have some sort of risk-control mechanism, since you mix various asset-classes," he says. "Because this is done by the manager you do not see the complexity. When you implement this strategy in a structured note, you have to explain it, write it down in a brochure - in this case we even needed three documents - so that's quite something. But the technique, in terms of managing the volatility of your investment, is no different from a CPPI or a mixed-fund or even what you get in a normal balanced portfolio."
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