Mark Wightman of SuperDerivatives discusses various trends related to the low volatility environment in the wake of the financial crisis, and looks at the impact on product appetite, structuring and sales.
Date: Feb 2010
Tags: Volatility, Yield, Structured products, Correlation
The second half of 2009 saw a considerable crunch in cross-asset volatility – which according to Mark Wightman was probably a response to the high levels of volatility during the financial crisis in 2007 and 2008.
When looking across FX rates, equities and commodities, for example, Wightman said there has been a significant reduction in volatility.
When it comes to interest rates, these have been low and flat for a long time in the major global currencies.
Hunting for yield
A post-crisis trend Wightman said he saw in the structured products market, for example, was a return by a lot of wealthy clients to vanilla products such as equity-linked investments (ELIs) and dual currency investments (DCIs).
However, he explained, these structures rely on investors selling an option, so when volatility comes down, they receive a lot less for the option premium, which equates to lower yields.
While DLIs and ELIs are simple to understand and have been commonplace in Asia over recent years, Wightman said that falling yields are now encouraging investors to look for ways to get higher yields.
There has therefore been an increase in risk appetite across Asia, he said.
As a result, callable range accruals in rates and FX have become more popular, he explained, as have auto-callables in the equity space – in both single and multi-name products.
Trends in correlation products
Wightman said there has also been interest in single asset-class correlation products, which could be in the form of baskets – as seen in the retail structured products market in Singapore in mid-February.
In the high-net worth space, he said there has been a return to some of the credit products which were off investors’ radars for a long time following the financial crisis. For example, investors are looking at credit-linked notes, as well as end-to-default baskets – where investors receive a yield if none of an underlying group of assets defaults during a certain timeframe.
Wightman said he hasn’t seen the types of complex correlation products available in 2006 and 2007, with a lot of the baskets now still based on single asset classes.
The issue for a lot of structuring banks, he explained, relates to the costs and challenges in hedging and managing the correlation risk.
Sales processes
Based on lessons learned from the financial crisis, Wightman said the banks are very concerned about potential mis-selling claims arising in the future.
This is leading them to provide a lot of documentation, to make it clear about the risks that investors are taking if they buy these products.
In the retail space in Hong Kong and Singapore, for example, Wightman said investors might now need to spend an hour to get everything explained to them by the distributor – driven by the regulatory focus on ensuring there is no repeat of what happened in relation to Minibonds and other products.
Preparing for a pick-up in volatility
According to Wightman, various market practitioners think volatility will pick up in 2010.
In the alternative space, therefore, Wightman said that volatility trading and macro funds might be an interesting space to invest.
From a wealth management perspective, he explained that investing in volatility can be done through straddles and strangles in the options space. Or investors might take a view on volatility through volatility or variance swaps, said Wightman.
Regardless of the products and tools used, the industry needs to provide comprehensive advice to investors.
Relationship managers need to be aware of the various products available to their clients, and to help them understand the impact of buying these products as and when the macro environment changes.
