In recent years, structured products have risen dramatically to the forefront of the financial markets. According to Bloomberg, the total structured product market accounted for over $7 trillion in invested assets.
That isn't surprising. In an environment of tighter credit conditions, very low interest rates, and elevated equity volatility, investors—both institutional and retail—are searching for products that deliver dependable yield while also providing features such as capital protection, leverage, reduced portfolio risk exposures, and access to new markets and diverse asset classes.
As we continue to see more demand for these products, market participants continue to seek the technology infrastructure that delivers the structuring, pricing and risk analytics capabilities needed to meaningfully engage in this marketplace and overcome the challenges of the past.
Dale Burke, product manager responsible for Numerix’s structured product trade management solution, Oneview for Trading, participated with Biju Kulathakal, CEO of Halo Investing, in a webinar discussion titled Capitalizing on Market Change: The Rapid Evolution of the Structured Product Market. These two structured products experts discussed a range of issues on the state of today’s structured products market, including market trends, performance, the rise of platforms, the role of speed, and the impact of COVID on the market, among other topics.
Here, we encapsulate the key elements of their discussion.
Platforms Deliver Real Differentiators
The emergence of multi-dealer platforms has increased growth opportunities in structured products, making it easier than ever to before to analyze, trade and monitor structured products. Vendors have evolved their technology solutions to better respond to the needs of pricing platforms and have helped to improve the technology underpinning how structured products are created, distributed and managed over the entire lifecycle.
Dale Burke: I believe the role of platforms will prove critical to the growth of business in the structured products market, especially for issuers. For example, platforms allow a new entrant into the business to go purely electronic and not have to hire its own salesforce. An issuer could focus entirely on managing risks, managing positions, managing life cycle events and allow the whole sales and distribution process to be managed through platforms.
Platforms serve other roles as well, such as they provide price discovery and price transparency, and do so quickly. You can get quotes in real time from multiple issuers and compare them to see which one is the best deal and then enable a fast transaction. From the issuer’s perspective, instead of relying on a salesforce for delivering quotes, which was not something that was ever easily handled, it is now maintained through platforms.
Biju Kulathakal: A platform provides transparency, easy liquidity, and solves a lot of traditional problems with structured products. Structured products are one of the largest markets in the world that even many professional investors have never heard of, and we want to change that by democratizing this product. Moving to a platform gives real time views on pricing and risk, and generally adds much more transparency to the market. This is what democratizes the market and is helping to draw people to it.
There is also a big demand for speed because customers want quick execution, pre-trade analysis and portfolio management tools. They want to know what they can get out of their investment quickly and want protection more quickly, too. This is another reason we see a big move to platforms— to electronic distribution.
Key Trends in the Marketplace
Another factor that provides strong appeal for structured products is their innovative strength, in the sense that they represent opportunities to rapidly participate in current and future markets and economic conditions. As a result, we are seeing a wider number of investors and market participants getting involved with these types of investments. Growing investor appeal also means competition between issuers is tightening. That’s why more and more market participants are automating the front office.
Kulathakal: One trend we’ve seen is that while structured products were traditionally sold through private banks to ultra-high net worth individuals, we are now seeing a huge demand for this sort of portfolio protection with a defined outcome across the mass affluent market. So, demand is moving from just, say, 1% of the population to a much bigger percentage of the investing population.
Because of this trend, we’re seeing the need to simplify the product and to make the terms of the product—and the analytics that surround it—easier to understand. This translates to what I call a “passive” trend, where investors want to be more protective with their portfolios. And I think this trend will reach a point whereby structured products move towards generating better overall portfolio outcomes.
Conversely, at the same time there is an opposite trend, which I call “active tactical”. This is about investors who are seeking more exotic payoff ideas and different payoff features. This sparks the trend towards more demand for products that have more complexity with the goal of further increasing yield. For example, 10 years ago autocall structured notes made up about 10% of the market, but now they make up around 40% to 50% of the market globally.
Burke: A trend we will continue to see longer-term is the move towards more automation and more usage of vendor platforms to help give issuers a wider distribution audience.
Another notable trend is that more banks are entering the market because they see it as a great opportunity to grow their client base. Investors are looking more at structured products because of the current extremely low interest rate environment. People are not getting the returns they want out of government and corporate bonds, so they are starting to look at more complex products to get the coupons they want.
Differences in Regional Usage
Since structured products have attracted considerable attention over recent years, they are now considered an investment staple in many markets across the globe. But there are still differences across global regions in terms of the size of the local structured products market as well as the types of structured products used.
Burke: Product usage certainly varies by global regions. Structured products find their most advanced usage in Europe. If you look at APAC, structured products are very actively used in Singapore and Hong Kong and have been for about the last 10 years. When you look at the United States, structured products usage is not quite as advanced as it is in Europe and APAC. This means there is a lot of room for the market to grow in the U.S.
In terms of product underlyings, in the U.S. about 80% of products are based in equities. In places like APAC, you’ll see a lot of the products based in the FX space. However, it really depends on the country and the unique characteristics of investor needs. Within North America, if you look at Mexico, for instance, investors there are interested in short term issues and it’s mostly FX based or rates based, with equities being a very small part of the market.
Going back to the theme of growing the market in the U.S., I just want to add the point that I think it’s really going to have to come down to investor education. It comes down to getting people comfortable with structured notes and educating them on what are the benefits of having that type of product in their portfolio.
Kulathakal: Global usage is extremely country specific and has to do with the needs of the local client base, which will be based on the state of the interest rate market there, the currency market there, and the equity market there. As Dale mentioned, the bulk of issuance of structured products in the U.S. is equities. Even though there’s a much bigger fixed income market in the U.S. than there is an equity market, from the structured product side, it dominates more on equities versus rates.
Now, if we move from the Northern Hemisphere to the Eastern Hemisphere and look at South Africa, as an example, we see that structured products investors in that country want very little exposure to South African underlyings, and instead prefer to buy U.S. and European underlyings because they want to hedge away from their local currency risk. These are only two examples, but it gives you an idea of how structured products usage is so country specific.
Impact of COVID on the Structured Products Market
The impact Covid-19 had on the structured products market—and the investment management industry in general—was multi-pronged. Not only were investment portfolios urgently reassessed in the spring because the coronavirus brought a decade-long U.S. bull market to an end and sparked a sudden market collapse, but focus and concerns also shifted towards market participants in the areas of risk, operations, technology, analytics, data and product distribution, among other issues.
Burke: With COVID, we saw five years’ worth of evolutionary market change happen in just six months. The market volatility presented by the onset of the pandemic put a huge focus on risk. Issuers required the availability of more reliable risk models, they wanted more pre- and post-trade analytics, they required more frequent and reliable market data updates, they wanted real-time price updates, and they wanted better calculation methodologies. This meant that companies such as Numerix had to build the software that provided all of that.
Kulathakal: Because of COVID, we saw a dramatic and accelerated shift to distribution through digital platforms. There has been a shift to platforms for a while because people want lower fees, more transparency, more data and soforth, as opposed to talking through all of that with a human being. Traditionally, these products were always sold through some sort of salesperson visiting you. But that couldn’t happen anymore because of COVID. Now, platforms still have human beings involved in the value chain, but those humans don’t do the full relationship building thing with you. They are more like a platform specialist, or someone who helps you with the platform.
The other impact we saw was that COVID helped to make structured products immensely popular. In March, everyone got the feeling that extremely low interest rates were here to stay while at the same time equities were rip sawing like crazy. So, fixed income was offering no sort of yield and equity risk was high, but structured products offered something in between: less equity risk and a higher rate of return than fixed income.