Derivative dealers in India have access to only a fairly limited set of structuring instruments: primarily callable puts and futures, although liquidity is very much skewed to the shorter end of the spectrum. And yet investors remain anxious for yield, especially in a world of falling interest rates. Edelweiss is named India House of the Year in recognition of its ability to make optimal use of the tools in the market in order to deliver generous returns to its clients.
The Mumbai-based securities house develops structures based on interest rates, currencies and commodities. However, by far the firm's most popular asset for structuring purposes is equity, since this is the asset class most traded in the marketplace and where liquidity tends to be greatest. Edelweiss says it will consider adding to its product suite as regulators open up the markets to new derivative structures.
In terms of risk management, Edelweiss relies on a few avenues for hedging its books. The most straightforward solution is to simply go to the markets, but with thin liquidity and tight regulation this isn't always possible. The securities house also has good warehousing capabilities and a diversified portfolio that can be used to offset risk in-house. When in-house risk mitigation is not an option, Edelweiss has established good relationships with global players active in the Indian market, who can sometimes provide longer-term hedges.
"As a diversified service provider with a very active wealth management business and large institutional and equity desks, we are able to offer the client the tailored high-yield solutions that they want at the moment," says Pratik Mittal, head of sales in the alternate solutions group at Edelweiss.
In 2014 and the first half of 2015, Edelweiss's standard autocall product was offering returns of between 16–20%. However, by the end of last year, the shine had had come off the product, largely due to a fall in crude oil prices, a high level of non-performing assets owned by Indian banks and persistently low interest rates. With returns having sunk to around 13–14%, Edelweiss had to do something to make the product more attractive.
"We had to figure out a way of building leverage into our product. We did this by shorting options within the product – basically out-of-the-money binaries – and forcing clients to take some marginal risk on their capital after a two-year period," says Mittal.
The duration of the product is 40 months. Up until the twenty-third month, the product generates returns of 18% per annum, but subsequently this drops back to fixed market rates. Principal is fully protected at maturity, but the client has the option of exiting the structure after the twenty-third month with 90% of the principal, which clients might want to do if they need liquidity or want to reinvest the money in another high-yielding product. It is that additional 10% that clients leave in the autocall structure that allows Edelweiss to buy additional options and bump up overall yield.
Edelweiss's diverse investment and client base also helps with the engineering behind the product.
"We run a large options book, and so when we want to short out-of-the-money binaries in one product, we can usually find clients with a bullish view of the market who will be looking to buy them. We can use these synergies to offload some of the risks of our book whilst at the same time delivering a different risk/return profile for a particular set of investors," Mittal says.