Some products offer protection if the bet is wrong, but very few remove the need for investors to make the two most important decisions for any type of investment: market timing and direction. Dynamic strategies, however, promise to take those decisions out of an investor's hands, providing a half-way house between static index products and discretionary funds.
"With these products, the strategy takes care of the cleverness, as opposed to the payoff," says Max Nelte, an equity derivatives structurer at Royal Bank of Scotland, which has recently started to roll out its dynamic strategies in Asia. "That means you're not stuck with deciding today what direction the market is going to take. This will allow you the flexibility of taking profits either way the wind blows."
RBS's most recent product to be imported is known as the Twister, which was originally developed for the Dow Jones Euro Stoxx 50 index. "The Twister plays on the fact that markets trend and that an effective way to identify the trend is moving averages," says Vivek Madlani, an exotics trader who works alongside Nelte in RBS's global banking and markets team in London. "It uses these measures to call when you've got an up or down trend and how strong it is, so you get a dynamic exposure that can be either long or short."
The strategy needs to be tweaked for Asia because emerging markets typically trend differently to developed markets. The Euro Stoxx product uses nine-month and three-month moving averages to determine the strength of a trend. So, if the underlying market is above its nine-month moving average the strategy would take that as a strong buy signal and would go 100% long. Conversely, if it is below its nine-month average that would be taken as a sell signal and the strategy shorts the underlying index.
At points between these two extremes the strategy adopts a less bullish or bearish allocation, depending on the direction of the signal.
The Twister is pitched as a dynamic strategy that performs regardless of market direction, but it out-performs its benchmark the most when the underlying is performing poorly because it can short the market in a downturn to generate positive returns, whereas it can only really track the market on the upside.
Back-tests of Twister strategies on Asian indices demonstrate this neatly. Since mid-1990 on the Nikkei, for example, RBS's Twister would have returned almost 175%, compared to a fall of more than 50% in the underlying index. But in Korea, between late-1998 and October last year, the Twister more or less matched the underlying Kospi index as it soared to record highs. And the same is true of India's Nifty index. But as both markets have tanked during 2008 the Twister strategies have once again delivered impressive returns against the underlying.
As the RBS team points out though, dynamic strategies are not "historical optimisation tasks". They are a smarter way to make money. "We're willing to see imperfections in what we design," says Nelte. "We don't want it to be perfect just so that our back-test shows 5% guaranteed every year for the past 30 years. We want it to be applicable and scalable so that the concept can be transferred to different assets or equity types."