What are investors in fund-linked trades typically trying to achieve?
The whole point of investing in funds is that you believe the manager is going to do better than their benchmark index. Structured products are ultimately about the underlying û if you don't believe in the manager there's no point buying a structure either.
There are three aspects to this market. First, there are pure market access trades û you get the performance of a fund û upside and downside û in the form of a derivative or structured note without buying the fund directly. Overall, this is a relatively small part of the business.
Probably around two-thirds of the business is in principal protected products, especially in the institutional space where investors are looking to diversify into active management, into hedge funds. Many of them are making their first investments into alternatives and, of course, if you're making your first investment in hedge funds you really don't want it to go wrong, so principal protection makes that first step a little easier. Basel II is another driver û for direct investments in hedge funds, the amount of capital that banks will have to set aside is going to increase by a factor of four.
Finally, about a quarter of the business is in leverage products, typically non-recourse leverage on a portfolio of assets. For example, investors may take $300 of exposure to the underlying fund from a $100 investment, but as it's invested on a non-recourse basis the most they can lose is $100.
How have investor attitudes to fund-linked products changed during the 10-years they've been around?
Today, the more experienced investors in hedge funds are shifting to leveraged products; this is where a lot of the growth is. Investors are getting more comfortable with the asset class and are looking for higher returns.
On a risk-adjusted basis hedge funds are actually still doing quite well compared to the 1990s, since while alpha has generally fallen in the 2000s, so has volatility. So investors are saying to themselves: 'If I'm making 9% to 10%, unleveraged, from hedge funds, I can leverage that two times and get close to the levels I was used to in the 1990s, with similar or even lower volatility.'
How does the market in Asia differ from Europe?
The important thing I've learned about Asia is that there is no such thing as an Asian market, but each Asian country has its own special characteristics. Japan has a large mass-affluent space, which is quite similar to some of the European high-net worth markets; there's good demand for principal protection in longer-dated structures and for leveraged products on hedge and credit fund underlyings.
Outside Japan, investors and regulators have definitely varied in their attitudes. In Taiwan, for example, there were some bad experiences with fund-linked products three or four years ago and that resulted in the market slowing down for all products, but we're now seeing a rebound.
In Hong Kong and Singapore the private bank market is somewhat similar to the one in Europe, though there is probably more demand for products with an Asian flavour, and Asian investors have a tendency to prefer shorter dated products. Also, the overall investor mentality, particularly in Hong Kong and Taiwan, is much more trading orientated.
You mentioned the problems investors had in Taiwan. How do you get past that reticence to use structured products?
It's all about education, getting investors and distributors comfortable with the features of the product û and making sure that the structures offered are appropriate. You know, you can use a chainsaw to cut down a tree or chop off your leg û it all depends on how you use it. There's quite good interest again in Taiwan now, but we will probably see much more conservative products than in the past.
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