Inside a fund of synthetic structured products

Funds constructed entirely from synthetic structured products incorporating exotic derivatives that could fundamentally redefine traditional approaches to risk and return have been around for some time.

Notably, they operate at significant scale while achieving full compliance with the rigorous Ucits framework, including its diversification requirements, which were designed primarily for retail investment funds to promote both investor protection and cross-border distribution. That said, the Ucits format is also highly attractive to many institutional investors for the same reasons.

We will discuss in detail the key aspects of such a fund, starting with its possible objective.

Objective of stable (lower-volatility) returns

A formulation such as the following could appear in a monthly factsheet

Currency:	GBP
Annual return:	7 to 8%
Horizon:	Mid- to long-term
Exception:	Severly distressed market conditions

An equivalent in CHF could be lower by around 4% / 4.5% versus the GBP one (considering recent UK-Swiss Government bond spreads in the 5- and 10- years maturities), so the target return could be formulated as 3 to 4%. Now, the fund may be denominated in one currency and offer share classes in other currencies that are hedged: this makes sense.

The objective in GBP is compatible with a large fund size – in the billions, not hundreds of millions. It should be noted that a minimum investment of several million in the respective currencies allows the fund to target a more “institutional”-type of asset base.

A factsheet may not show the volatility of the strategy.

Portfolio construction

The fundamental investment consists of high-quality government bonds. Associated with a series of autocallable swaps in the reference currency, each with different major equity indices as the underlyings, and featuring a multitude of typically large investment banks as counterparties. It is typically only large investment banks that can offer these exotic derivatives (the autocallable swaps) in the necessary sizes. But what are autocallable swaps?

Autocallable swaps are structured derivatives (because they comprise different instruments) that combine over-the-counter (OTC) exotic derivative contracts.

They feature a swap on an equity index where, on one side, there is an automatic early termination feature known as the "autocall" which is tested on specified observation dates. If the reference underlying (the equity index) meets a predetermined condition (most commonly being above the specified strike, typically the initial value of the index), the swap automatically terminates and a settlement payment is made.

Additionally, at the swap's expiration, there is a (short) terminal barrier (down-and-in) put option that, if triggered, becomes a plain-vanilla short put and causes losses. If the index final value is above the barrier, the put option simply does not appear (as a plain vanilla put) and the investor gets the notional amount back under the implied /synthetic structured product. The structure can be further complexified, of course.

It is the autocallable swap that allows for an increase in the coupon of the implied /synthetic structured product. The synthetic product is actually an autocall barrier reverse convertible (AC BRC). You may also want to read our article on Fugit, which is relevant because autocallable products may terminate early and therefore have an uncertain expected life - Fugit being the measure of that expected life.

Fees

While management fees would not be excessively high, they are a normal feature, and one cannot reasonably expect a performance fee for such a fund given its precise return target range.An OCF / Ongoing Charges Figure (also known as the TER / Total Expense Ratio) of 60 to 70 basis points (bp) is realistic.

Dual volatility impact

In a scenario where volatility increases, as was the case in April 2025 (US tariffs), the portfolio will experience two types of impacts. The value of the autocallable swaps will show a loss or gain reduction, because the probability that the equity index ends up below the barrier increases. On the other hand, new autocallable swaps will benefit of the higher volatility: the short down-and-in put will sell for more.

A simple example of an auto-call barrier reverse convertible (AC BRC): strong volatility increase case.

In the following table we show how the price of the simple AC BRC would decrease with a strong volatility up-move. The effect would be even more pronounced if, as one would expect, the price of the underlying also decreased (sharply).

AC BRC price simulation (our model)	On 01-01-2025	6 months later
Currency	USD	USD
Notional	100	100
Start date	01/01/2025	01/01/2025
Maturity date	01/01/2028	01/01/2028
Underlying value	1,000	1,000
Volatility	20%	30%
Annual coupon	8%	8%
Coupon barrier	80%	80%
Autocall start date	01/01/2026	01/01/2026
Autocall level	100%	100%
Dividend yield	1.50%	1.50%
Risk-free rate	4%	4%
Price	98.82	96.3

AC BRC price simulation (our model)	On 01-01-2025	6 months later
Underlying value	1,000	900
Volatility	20%	30%
Price	98.82	90.21

Embedded risks/Market risks

Tthe Delta for each underlying equity market is typically reported individually, along with the total (aggregate) portfolio exposure. From the investor's perspective, Deltas are generally positive, reflecting the long economic exposure to the underlying equity market(s). However, the relationship between Delta and spot level is nonlinear and non-monotonic.

When the underlying is well above the autocall barrier, Delta tends to be low, as the product is highly likely to autocall and behaves similarly to a short-dated bond.

As the underlying falls toward and between the autocall and knock-in barriers, Delta generally increases, reflecting growing sensitivity to further market declines and the increasing probability of knock-in.

Near the knock-in barrier, Delta can spike sharply due to the discontinuous payoff at the barrier (high Gamma region).

Once the knock-in barrier has been deeply breached, Delta stabilizes at approximately 1.0 (normalized), as the product effectively becomes a linear long position in the underlying.

Additionally, near observation dates, Delta can exhibit significant discontinuities due to the binary nature of the autocall trigger. These "digital risks" or "Gamma spikes" near barriers are key hedging challenges for issuers and should therefore be carefully monitored.

There is also an FX risk if there are multiple underlyings in the fund denominated in different currencies or if the fund offers different reference currencies (one for each share class).

Furthermore, there is usually a scenario table presented to the investor that includes a stress-scenario with a sharp drop in equities (for example a -20% or -30% decline). In that case, the autocalls would not be triggered and the Fugit (the expected life of the product) would approach the final maturity of the autocallable swaps (although lower than the weighted average maturity, since equities could recover in the meantime).

Consequently, the fund’s return is logically “capped” in an optimistic scenario for the equity markets: in such a case, the existing autocalls would trigger early one after the other, meaning the investor receives their fixed (high) coupon but does not participate in any further market upside. Very importantly, is this “cap” needs to be above the minimum return objective -at least long term.

Credit risk: the credit risk (explicitly mentioned) of the various counterparties should be diversified across investment banks for the Autocallable Swaps. In addition, the possibility of default by bond issuers is also noted. Depending on the type of government bond, some may argue that such bonds are credit-risk-free; however, in reality, this is not strictly the case

Liquidity risk: this arises from the fact that the fund may not be able to enter or exit positions without having an impact on the market. It is especially important to consider in stress-situations when exotic derivatives are used extensively

Operational risk: is typically addressed but only in the context of a general definition

Derivatives risk:  may be highlighted separately, with its market and credit risk dimensions

Historical performance

While not intended to beat US large cap equities, which have a higher long-term average (annual) return, such a strategy for which a 10+ year track record exists in GBP, has achieved a return since inception that is in the expected range, even though at the lower end. The US large cap contributes the most, by far (when compared to European and UK large caps).

In that time frame, the drawdowns in equities related to Covid in 2020 and the U.S. Tax events in 2025 also led to a fall in the price of such a fund: exactly as modeled in the stress scenarios. In both cases, the (equity) markets recovered pretty quickly.

In our next article, we'll return to our regular series on structured products and the Greeks, with the stimulating thematic of the correlations within multi-underlying structured products.

_{Image: Who is Danny/Adobe Stock}

---

_{Disclaimer: This content is not intended as a solicitation or an offer; it is provided solely for informational purposes to professional investors. The information presented herein has been prepared with great care; however, errors may still occur}