Source: structuredretailproducts.com, up to end March 2021
The above table and chart were published in April’s Tricio Monthly insights. They showed the estimated sales and average notional size per issue for UK retail structured products have been dropping since 2017. I discussed some reasons in April’s Monthly Insights, including the difficult pricing environment that affects product terms. Decrement index, mentioned in my previous blog, is one innovation that banks introduced to address this issue.
Many industry participants and product providers were arguing that as central banks keep interest rates low, the pricing environment will not improve back to pre-2017 levels for a while. What the UK structured product market needs is more innovations that improve the headline rate to address investors’ needs for returns.
Market participants pin their hopes on innovations because historically, significant growth in the structured product market was driven by game-changing innovations. When I first got involved in structured products for UK retail investors in 1996, the innovation was to package capital protected products in tax free investment wrappers, which started the structured product market for retail investors. At the turn of the millennium, banks came up with new ways to issue structured notes as a bond in which returns are taxed as capital gains rather than income. These capital gains tax (CGT) notes helped to reduce costs in launching a product. This in turn resulted in the rise of independent plan managers in distributing structured notes issued by different banks to investors.
In 2002/2003, the first “autocall” or “kick out” product was launched. This innovation addressed the investors’ reluctance to lock their money in a structured product for several years. Now, investors can get their initial capital back plus gains before the maturity date if the underlying index (or indices) stays flat or even drops slightly. This strategy can be very useful for advisers in managing pension draw-down to minimum the impact of future market performance on timing of the draw-down (‘sequencing risk’). Kick out products also fit the commercial needs of the banks and product providers from reinvestments after a product has matured early (“kicked out”).
There are other innovations that I have not mentioned – I hope to cover them in future blogs and podcasts. Apart from kick out strategies, most of these game-changing innovations have little to do with just product terms improvement. They were not driven by smart derivative strategies or new underlying indices. Instead, their successes were due to the genuine alignment of all stakeholders interests in the distribution chain: from banks, product providers, plan managers, platforms advisers to end investors.
The next game-changing innovation will be driven by technology
So, what will be the next big game-changing innovation? There is always a possibility for a ground breaking payout strategy like kick out to emerge. But I think the more likely innovation is not driven by derivatives or financial engineering, but by technology.
Today, there are plenty of online investment platforms that allow you to invest in mainstream investments, whether you are advised or self-investing. Some even allow you to buy or sell funds, investment trusts and shares easily on your smart phone. This is not the case in structured products in the UK. Many industry participants will say that is because of regulatory requirements, where structured products are often offered to advised clients only. But in this situation, isn’t the smart use of technology the way to make things easier for both advisers and investors? Using technology to help distribution will reduce costs. A lower cost means better product terms for end investors.
For product providers and plan managers, one of the biggest risks is under-selling (or over-selling) a structured product that they have underwritten where the price has gone down (or up). Technology can help them monitor the sales pipeline better, which in turn can help them to manage this risk better. This sale risk can be reduced further by shortening the offer period of the product, which is possible when more technology is used to process investments.
Structured products are often used by investors to express their market views. Kick out is a good example –getting a return even if the market stays flat or slightly down. One can also build structured products around investment themes that the investors believe in, with some degree of control over downside risk to their capital. Such bespoke or customised structured products are common in private banks, but are not offered to retail investors as they don’t have the investment size like private bank clients. Again, technology can help by pooling smaller orders together for the banks, aggregating and managing the risks across all these small customised products more effectively.
Lastly, technology could allow banks and distributors to engage investors and advisers who have not yet considered (or reconsidered) structured products in their portfolios. Possibilities include online educational materials on structured products, live chats with product specialists, and seamless integration with other common investment platforms to help those who avoid structured products due to operational issues. By engaging these new potential clients, we can do more than preventing the structured product pie from shrinking. We can start growing the pie again.
James Chu CFA
Head of Investment Solutions