Commodities and green themes will become even more dominant as underlyings for structured products, discovers Pablo Conde.

1. Commodities
Having provided both stellar returns and a low to negative correlation to bonds and equities, commodities unsurprisingly take joint first place in our rankings with eight votes. Nevertheless, they are still a minority investment, representing just 2,400 products, or $160bn in face value, in a database of 600,000+ products.

Chris Warren, DWS's American head of structured products, says commodities are the only theme that has had some level of appeal in the US market. "I think the theme-based approach is coming to the US but I don't think the structured product arena is ready... The idea of creating a brochure for a structured note only happened in Dec 2005," he says.

"Some of the themes introduced last year, such as alternative energy or the agricultural themes (either as a direct investment in soft commodities or equity) will continue to be popular among retail investors," says Philip El Asmar, managing director, head of solutions sales, Americas, Barclays Capital.

"The key is how you actually make the most of that theme, maximising returns for investors and allowing the bank to stand out from the crowd," adds RBS's managing director for private investment products Zak de Mariveles.

RBS launched the first commodity-based Ucits III fund linked to the Jim Rogers' Rici Enhanced Global Commodities Index, a highly diversified, actively managed, commodity index: "When one looks at the back testing, it has offered a significant uplift, thanks to Jim's insight into the world of commodities," he says.

Examples:
HSBC Optimised Global Agriculture Price Return Index: uses a rules-based quantitative model to capture returns from a dynamic and highly diversified portfolio of liquid companies directly linked to food yield enhancement, crop protection, plant growth, and disease resistance.

Dow Jones AIG Commodity Index Total Return: comprising futures contracts on physical commodities.

S&P GSCI Commodity Index: a diversified long-only investment in commodity futures, whose returns are calculated on a fully collateralised basis with full reinvestment.

Rici Enhanced Global Commodities Index: the Rogers International Commodity Index (RICI) comprises 36 futures contracts further broken down into three sub-indices: agriculture (34.90%), metals (21.10%), and energy (44.00%). Weightings attempt to represent consumption patterns worldwide in developed and developing countries with liquidity constraints.

2. Green themes, water and alternative energy
The surging interest in solutions to the problems associated with global warming and climate change, the need for alternative energy sources and resource efficiency, as well as the scarcity of natural resources such as water and foodstuffs, colours the structured products palette in hues of green.

Green themes came joint top of our top seven ranking, with eight votes. Although it is difficult to quantify the number of products, given the variety of underlying links, we have identified more than 2,500 existing products with an estimated sales volume of around $34bn.

"According to a keynote speech in June by [UK prime minister] Gordon Brown, this industry, which includes renewable and nuclear energy, waste management, pollution control, energy efficient products and so on, will be worth $700 billion dollars by 2010 - the size of the global aerospace industry," says de Mariveles.

S&P's Steven Goldin adds a warning, however: "These themes have a seasonality linked to them and their popularity will depend on what is going on around us, which is unpredictable," he says.

"You typically need a three- to five-year product to allow an investment theme to materialise and realise its full benefits, but at the end of that investment horizon, the same theme may not have the same compelling positive fundamentals versus alternative ideas," adds de Mariveles.

Although index providers dominate this area, alternative and environmental-based investments have become pivotal for banks and specialist providers.

Examples:
FTSE Environmental Opportunities All-Share index: over 450 constituents with a minimum 20%  revenue derived from environmental markets or technology, selected from the FTSE Global Equity Index Series.

S&P Global Thematic Index Series: three sub indices track the largest publicly-listed companies that meet specific size and liquidity criteria, cut across traditional regional and industry classifications.

Dow Jones Sustainability Indices: use a 'corporate sustainability assessment'.

SG Wowax: an equally-weighted benchmark of the 20 largest companies in the fields of water
utilities, water infrastructure and water treatment.

ABN Amro Change & Environment Index:
30 constituents earning more than 25% of their revenue from areas including water, waste management and ethanol.

3. Emerging markets
Third place in the ranking went to emerging markets, a theme that is often difficult to separate from infrastructure.

Many observers agree that the fundamentals of many emerging markets are much stronger than indicated by their equity valuations and that emerging market equities will continue to outperform developed markets, especially in the face of a US recession: "Emerging markets and especially Bric will be a big theme in the short term, as well as the Middle East, which will be favoured by investors as a recurring theme. In the fixed income arena, we will see products linked to emerging market debt or currencies," says Barcap's El Asmar.

"We look for sustainable features when identifying a thematic index," says Steve Goldin. "Emerging markets provide many sustainable features such as energy, infrastructure, eco-forestry and natural resources demand. If we look at the underlying dynamics, two of three drivers of emerging market growth are intact: high domestic demand and the drive to bring infrastructure up to western standards. The third driver, exports, is being damped by the slowdown in the developed economies."

Examples:
S&P Bric40 Index: the 40 largest and most liquid companies in Brazil, Russia, India and China (Bric), using a modified market cap weighting scheme to reflect available float, reduce single stock concentration and enhance index basket liquidity. All stocks trade on developed market exchanges.

Dow Jones Wilshire Emerging Markets Index: applies IMF standards to determine constituent countries, with large-cap, mid-cap and small-cap indices available.

FTSE Research Affiliates Fundamentals Emerging Index: the 350 emerging markets companies with the largest RAFI fundamental values, based on economic footprint measured by dividends, cash flow, sales and book value.

Barclays Global Emerging Markets Strategy (Gems) Index: reflects the total return, including exchange rate movements and implied local deposit rates, of US dollar investments in the 15 emerging market currencies in the index.

4. Socially responsible and sustainable development
Fourth on our list is a group of themes that takes in religious principles as well as socially responsible and sustainable investment. According to a Dow Jones presentation in January this year, socially responsible investing, including faith-based investing, accounts for US$4tr worth of assets under management, with annual growth of 20%.

European SRI assets are worth nearly $1.75tr and Asia-Pacific assets $22bn, according to Dow Jones.

While religious themes have so far been taken up by their respective cultural adherents, it is often argued that the religious considerations underpinning Shariah-compliant, Hindu or Buddhist 'dharma-based' investments provide the basis for sustainable development.

Other underlyings accord with international standards, such as the ten principles of the United Nations' Global Compact, or proprietary screening methods. It is difficult to measure the presence of these products on the SRP database because they fall under such very different labels and even spellings, but, by way of snapshot, we have, for example, 31 products globally using the word sustainable in their title, with a definite pick up in issuance this year.

Examples:
FTSE4Good Sustainability Index: companies working towards environmental sustainability, developing positive relationships with stakeholders, and upholding and supporting universal human rights. Excludes tobacco, weapons, and nuclear power.

Dow Jones Islamic Market China Offshore Hong Kong Index: companies that have been screened for compliance with Islamic principles, whose primary operations are in mainland China but that trade in Hong Kong and the US.

DJ Dharma Indexes: stocks compliant with the code of moral conduct according to Hinduism, teachings of the Buddha and incorporating principles of the Sikh and Jain religious
tenets. Global and national indices available.

5. Inflation
"Over the last two months, we have seen a tremendous demand for inflation-based structured products," John Radtke, president of independent US distributor Incapital, told SRP.

Inflation came fifth on our observers' forward-looking list. We have 377 products using inflation as an underlying, either singly or in combination with another asset, on the global SRP database.

6. Infrastructure &  7. Frontier markets
The last two spots on the list are taken, respectively, by infrastructure and frontier markets, two themes that often appear together. A number of providers are offering products linked to frontier countries like Nigeria, Mexico, Eastern Europe or Vietnam, either through passive indices or specialised funds. "The infrastructure basket is [an] interesting [way] to access to these markets as well," says Virginie Pelletier, head of equity and fund derivative sales for Europe at Fortis Global Markets.

"When you look at emerging markets, one of the themes is infrastructure such as roads, rails and airports... This is one of the areas where we see a lot of interest and a lot of activity", adds de Mariveles.

Examples:
S&P/IFC Global Frontier Markets Index: Bangladesh, Estonia, Lebanon, Slovak Republic, Botswana, Ghana, Lithuania, Slovenia, Bulgaria, Jamaica, Mauritius, Tobago & Trinidad, Cote d'Ivoire, Kazakh-stan, Namibia, Tunisia, Croatia, Kenya, Panama, Ukraine, Ecuador, Latvia, Romania and Vietnam.

MSCI Frontier Markets Indices: aim to achieve a broad representation of the opportunity set, with investability constraints.

Dax Global Emerging 11 Index: Egypt, Bangladesh, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey and Vietnam.

We asked ten key industry players* to predict which investment stories will continue to be hot topics for the short- and mid-term horizons. The results are tabulated below, left with a discussion of the nuances of these investment themes appearing below.

Algorithms
Algorithms do not appear as a theme on our Top 7 table, but every bank and product provider we spoke to became animated when talking about quantitative investments, whether based on their own research or that of index providers. The best-known algorithm is CPPI, which optimises allocation to a risky asset without putting capital at risk.

CPPI accounts for 1,739 products with an estimated sales volume of $182.2bn, according to SRP data. More recently, however, the mathematical approach has been used to seek out alpha, rather than to smooth the volatility of market beta.

"All the large banking firms have some kind of quantitative framework to analyse liquidity and find the best strategy for execution. Algorithms will add value to a catalogue of products... The Markowitz model allows dynamic allocation of up to four different asset classes," says Thomas Valentiner, senior vice president at Danish Garanti Invest.

"We have seen recently in the retail market dynamic management strategies such as vol capping starting to become accepted," says de Mariveles. "It is a very useful feature to have a product that automatically manages its own volatility by increasing/decreasing the exposure on the underlying asset based on its realised volatility.

"The higher, the volatility the less exposed you become, the aim being to maintain a steady smooth return, even when you're investing in highly volatile markets."

Examples:
S&P Dynamic Multi-Asset Strategy Index: based on macroeconomic and valuation metrics with three separate decision signals and six-monthly rebalancing.

Dow Jones Required Business Performance Index series: indices measure the likelihood that a company can deliver the performance required to support its current stock price.

S&P Diversified Trends Indicator Index: a diversified composite of long and short commodity and financial futures positions designed to provide exposure to major global market trends.

*With thanks to: Thomas Valentiner (senior vice president from Garanti Invest), Chris Warren (managing director and the head of structured products America, DWS), Stefan Wagner (global head of structuring & product strategy and European head of structured products), Graham Devile (Meteor AM, managing director), Philippe El Asmar (managing director, head of solutions Sales, Americas Barclays Capital), Virginie Pelletier (head of equity & fund derivative sales for Europe, Fortis Global Markets), Steven Goldin (S&P head of products, Europe and Middle East), Imogen Dillon Hatcher (managing director, FTSE), Jamie Farmer (senior director of global index operations and head of exchange relationships, Dow Jones).