Over the past five years, the behaviour of the equity markets has changed significantly: unprecedented bearish share price movements in 2000–2003; increased correlation between equity markets; development of derivatives on non-equity asset classes and alternative investments. In such market conditions, investors have been seeking to extend the scope of traditional investments outside pure equities in order to benefit from the performances of other asset classes. However, choosing the right market to invest in remains a difficult exercise.
Hybrid structures are derivatives based on distinct asset classes ie, combining interest rates, currencies, gold prices, commodities, etc, along with equities. In one single product, hybrids can provide simple access not only to equities and bonds but also to a wide range of asset classes, including new markets with high potential but which are usually hard to invest in directly: oil, gold, currencies, base metals, etc. Such multi-underlying exposure ensures:
• Diversification of directional risk. Hybrid structures replicate the returns from a diversified portfolio.They allow investors to benefit from performances in any market conditions, as the distinct asset classes have different economic cycles; low overall portfolio volatility, as the mix of assets is designed to optimise the investment’s risk/return profile; and low historical asset correlation.
• Protection against inflation. Several equity-based structures provide inflation-linked minimum returns.
• Arbitrage between different asset classes. Investors can take advantage of return differentials between various asset classes without putting their invested capital at risk, by switching from one strategy to another, eg, sale of bonds against purchase of equities.
Hybrids thus offer a broad variety of customised investment opportunities for investors looking for capital preservation over time, diversification across markets and enhanced returns in all weathers.
Hybrid structures for all investment objectives
Major derivatives houses, such as BNP Paribas, have developed a wide range of hybrid payoffs. The structuring process seeks to create innovative solutions to address any investor’s objective:
• Multi-asset payoffs – Structures such as lock-in hybrids offer a lock-in mechanism to capture any underlying rise, with no cap on the payout.With this mechanism, investors secure performance and benefit from the decorrelation between the selected markets. Also, these products provide capital protection as soon as all the assets have achieved a positive performance at the end of a period. In return for accepting some capital risk, investors are offered unlimited upside. Recently, profiled investment solutions have been developed. They provide exposure to several asset class baskets, each with a specific risk profile, from conservative to aggressive.
• Inflation-indexed payoffs – Structures such as best of inflation pay out the better performance between an inflation index and an equity option. Such structures are very flexible, as any equity-linked payoff can be guaranteed against inflation.
• Combined strategy payoffs – Structures such as Orion pay out a fixed return at regular intervals, provided that short-term interest rates stay below a certain upper limit. Once this limit is breached, the product turns into an equity-linked payoff structure. Investors receive fixed returns in low interest rate environments and may switch to equity upside exposure when economic conditions turn favourable. Other structures such as callable multiple range accrual notes pay a high coupon if both the forex rate and another index (fixed income, equity, or commodity) stay within specified barriers.
All these hybrid structures can be tailor-made to fit each investor’s preferences and requirements.
BNP Paribas, world leader in hybrid products
BNP Paribas’ strengths in hybrid derivatives lie in the bank’s capacity both to innovate and to tune in carefully to market needs before developing new product ideas.Working in close partnership, the hybrid groups in fixed income, commodities and equities & derivatives divisions and the new products teams at BNP Paribas have created a wide range of innovative structures allowing investors to benefit from the disconnection between markets.
| Contacts |
Guillaume Cornut (Fixed Income), Sebastien Lemoine (Commodities), Guillaume Picot (Equities & Derivatives), Heads of Hybrid Trading at BNP Paribas.