Lookback

Structured Products casts an eye over some of the more noteworthy findings to affect the industry during the past month

Investors in Asia have expressed their dissatisfaction with equity and bond indexes, which are falling short of their requirements, according to a survey by Edhec-Risk Institute in partnership with exchange-traded funds (ETF) provider Amundi ETF.

Though 71% of equity index users surveyed expressed satisfaction with current indexes, the report says such a level implies that there might be issues associated with industry standard practice on index construction. The survey of asset and fund managers, institutional investors and private wealth managers also found that only half of respondents that use fixed-income indexes are satisfied with them.

"A key finding is that the rate of usage for these indexes is very high [but] at the same time the rate of satisfaction is low," says Felix Goltz, head of applied research at Edhec-Risk Institute in Paris. "However, while investors aren't very satisfied, no clear alternative is emerging," he says. "Many indexes don't provide full transparency or they contain discretionary decisions, which is something investors are very critical of."

Issues relating to standard capitalisation-weighted equity indexes, such as concentration risk and lack of diversification, were highlighted as significant problems by almost two-thirds of respondents.

"Market cap-weighted indexes have a bias towards bigger companies and they don't have the diversification characteristics that you have in a portfolio consisting of equally weighted companies, for instance," says Paul Thind, head of custom indexes for Asia-Pacific at Royal Bank of Scotland in Hong Kong. "Such issues have led to the creation of fundamental and equally weighted indexes, which are attracting increasing interest among institutions."

Many indexes don't provide full transparency or they contain discretionary decisions, which is something investors are very critical of

Some of the most important criteria for investors when selecting or assessing an index were liquidity, objectivity and transparency, which was deemed a key factor by 88% of respondents.

 

Dual-directional structured products, which are typically aimed at retail investors, are "exceedingly complex" and "tend to be priced at a significant premium to present value", according to a research report from Virginia-based Securities Litigation and Consulting Group (SLCG). The report also finds that dual-directional products with leverage on upside returns have a far lower average value than their unleveraged counterparts. "They are more poorly priced than the more transparent products," says Tim Dulaney, senior financial economist at SLCG.

The research comes in response to a big increase in issuance of such products. While last year saw only three issued in the US, 35 have been launched in 2012 as of May 1, according to the report. JP Morgan is the largest issuer, followed by Morgan Stanley.

The products combine features of absolute return barrier notes, buffered plus structures and reverse convertibles in order to offer investors the same returns whether the underlying asset rises or falls in value. In doing do, the notes achieve ‘straddle positions' - both buying an at-the-money call and an at-the-money put, according to SLCG. Dual-directional notes are also known as straddle or bull-bear notes. The best scenario for investors in this type of structure would be a moderate up or downward movement in the underlying.

 

Royal Bank of Canada has paid a settlement of $2.9 million to exchange-traded fund (ETF) investors in the state of Massachusetts over the sale of leveraged and inverse funds. According to the consent order, the bank allowed its registered representatives to offer and sell the funds to clients without the registered representatives completely understanding how the products functioned. For example, one representative described leveraged ETFs as a suitable product for an investor who had an investment objective of "conservative" because the investor is "using half as much money to basically get the same type of performance... but with half the amount of money."

 

The evaporation of fixed-income yield is set to look even more pronounced when account is taken of inflation expectations, according to an iShares report. Fixed-income investors have been left with the difficult choice of moving further out on the risk curve or accepting lower yields, says a strategist at iShares, the exchange-traded funds (ETF) subsidiary of BlackRock.

"It is a mistake to seek incremental yield in the form of longer duration," says Russ Koesterich, global chief investment strategist at iShares in London and author of the report. "While yields could certainly go lower in the event of another crisis or a sustained bout of deflation, long-term there is a greater risk of inflation than deflation."

In Navigating Fixed Income Investing in a Low Yield World, Koesterich notes that investors in long-dated US Treasuries are not merely settling for lower returns but also taking on considerably more risk.

Although investors in emerging markets were worried about inflation in 2011, their concern appears to be easing, he says. With the exception of India, a slowdown in inflation is already evident in most large emerging market countries. Koesterich expects emerging market bonds to offer significant and historically high premiums over most developed market debt. Currently, emerging market bonds are yielding roughly 350 basis points over 10-year US Treasuries, close to a record high.