Hybrids

Structured Products Europe Awards 2007

The high levels of correlation between assets during the past few years has improved the pricing of hybrids derivatives. Together with rising demand from investors with specific views on cross-asset correlation, this has ensured that volumes of equity-linked hybrid products trades have increased.

"We have seen significant rises in demand for equity-linked hybrids since 2000," says Hassan Houari, managing director, head of equity derivatives structuring at Barclays Capital in London. "About 20-25% of the enquiries received by the equity derivatives structuring team are about equity-linked hybrids," he says.

Barclays Capital has completed close to 400 hybrids trades since 2000 and has a notional of more than $2 billion in assets under management in these trades. In June, the bank placed a $45 million hybrid deal, which was a best-of-two-strategies, capital-protected, three-year US dollar note developed for a global private bank combining five different asset classes: equities, bonds, commodities, hedge funds and real estate.

The note weights asset allocations to produce both an aggressive and a conservative strategy, with the payout at maturity linked to the best performer of the two and providing 130% leverage on the positive return. In response to rising demand for secondary market liquidity, BarCap also offers to provide daily liquidity for the best-of product by tracking the performance of the underlyings.

Although some short-dated pure equity-linked products have recorded mark-to-market losses in recent months as volatility has increased, this is unlikely to have a significant impact on long-dated correlation. The spike in volatility has therefore had little influence on pricing these trades, which tend to have investment terms of between two and seven years, says Houari. "We expect the notional assets under management in hybrids trades to grow from $2 billion to $3 billion in the next year," he says.

In June, the bank issued an autocallable equity-linked hybrid note with a three-year tenor to a Spanish bank, which distributed the note to its retail network and private banking investors, raising EUR13 million ($18.4 million). The product is linked to three renewable energy stocks and the Goldman Sachs US Energy ER commodity index.

The note pays a yearly coupon of 6.5% if the performance of each of the stocks is above their initial level and pays a bonus coupon of 6.5% if each of the three stocks outperforms the index.

Another structure designed by the bank this year was based on an option on constant proportion portfolio insurance technology. The EUR50 million deal, which was delivered via a third-party issuer, was sold to a French private bank and distributed through life insurance policy contracts in Europe. The Maestro TrendSpotter guarantees a 17% return at maturity and a 20% floor on the allocation to the TrendSpotter index, which consists of an allocation mechanism that selects three assets from a pool of eight indexes covering equities, fixed income, hedge funds and commodities.

Private banks and retail banks are impressed with BarCap's structuring skills, ideas and pricing. "Barclays Capital is one of the top three houses for hybrid derivatives," says Isabelle Malattre, structured products dealer at HSBC private bank in Zurich. "It is the number one house when it comes to providing good pricing for underlyings."

Institutional investors such as pension funds have also been seeking equity hybrids exposure. In December 2006, BarCap structured a 10-year note distributed by a Swiss asset manager to European pension funds. The Sfr23 million ($19.6 million) transaction is linked to a basket of emerging markets indexes: the CECE Composit Index in euros, which covers Poland, Hungary and the Czech Republic; the S&P CNX Nifty 50 Index in India; the Hang Seng Index in China; the DJ AIG Commodity Index; the Goldman Sachs Commodity Index; and the S&P Latin America 40 iShare Index.

The weightings given to each of the indexes could be adjusted to suit the particular views of the product's investors. The 100% capital-protected note offers a participation of 85% and returns are linked to the best semi-annual floored Asian basket performance calculated from the initial level. The product enables investors to take a long-term view on emerging markets and commodities.

Few structurers have BarCap's ability to provide quick pricing and liquidity for hybrid structures.