In the low yield, low volatility environment of the past seven years, there has been a yawning gap between sales of capital-protected and capital-at-risk retail structured products. Since 2010, capital-protected product sales are projected to be down 64% and capital-at-risk product sales up 54% by year end. “The principal protected market has declined over the past few years, because yield and volatility have declined dramatically over the years, and the characteristics that clients are looking for in products are not achievable while maintaining a level of capital protection,” said Joe Halpern (pictured), chief executive of Exceed Investments.
In order to attain an attractive yield, investors have been forced to make sacrifices in capital protection. When yield and volatility were higher it was possible to structure, for example, a fully capital-protected with a 20% cap on the upside return. In today’s pricing environment, that same product is not possible without increasing the risk: either the level of principal protection must decrease, the term must increase, or the cap would have to decrease.
Since the US database was launched in 2006, sales of products that offer no capital protection have been greater than sales of capital-protected products every year, with the exception of 2010. The spike in sales of capital-protected products is the result of a series of 10 senior fixed rate step-up callable issued by Morgan Stanley, worth a collective $4bn. Even when the figures are adjusted for this discrepancy, the gap between sales of capital-protected and non-protected products has been yawning, and projections of sales figures for the end of 2015 do not show the trend slowing.
“Investors are seeing the cost of principal protection and opting to go with at-risk products that they feel have better economics,” said Deryk Rhodes, managing director, head of structured products trading at Incapital in a recent interview. “Wirehouses/private banks and institutional investors tend to be a bit more sophisticated and typically focus more on non-principal protected structures. However, with the ongoing educational efforts by distributors and issuers, we’re seeing increased demand among regional broker dealers and even bank channels for at-risk structures.”
Sales of retail structured products with no capital protection stand at $22.3bn this year and are projected to rise to $35bn by the end of the year, an 11% rise on last year’s sales. Sales of capital-protected products stand at $5.9bn and are projected to end the year at $9.3bn, a 2% fall from last year. The general consensus among analysts is that the US Federal Reserve could raise interest rates as early as September, which would improve the economics of structuring capital-protected products, and in turn raise demand for these products.
“As rates go higher, we expect to see increased demand for capital-protected, market-linked investments, potentially shorter tenors and improved economics,” said Rhodes. “However, we anticipate that the upward trend for principal at-risk trades will continue. We have seen that once investors understand and begin investing in at-risk structures they typically stick with them.”
Halpern says, “If the Federal Reserve increases rates, and if there is a belief that rates will continue to rise, then yields will increase. With increasing yields, there will be better opportunities to provide principal protected products with shorter relative durations and better characteristics.”
JP Morgan holds the top spot for sales of products with 100% capital protection and without capital protection. This year, registered notes accounted for all of the volume for capital-at-risk products, while capital-protected products were evenly split between registered notes and certificates of deposit.
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