Issuance doubles to $860 million; appetite grows for innovation, complexity in volatile market

By Emma Trincal

New York, July 21 - Structured products issuance more than doubled in a week marked by the prevalence of sophisticated structures and innovation.

Agents sold $860 million in the week ended Friday, up from $372 million the week before, with the number of deals jumping to 59 from 39, according to data compiled by Prospect News.

The top deal - Barclays Bank plc's new listing of its ETN+ Inverse S&P 500 VIX Short-Term Futures exchange-traded notes due July 17, 2020 linked to the inverse performance of the S&P 500 VIX Short-Term Futures Index Excess Return - was a novelty giving investors access to a short exposure to U.S. volatility markets for the first time.

The bank priced $250 million of the ETNs, which are listed on the NYSE Arca under the symbol "XXV."

ETN fervor

ETNs continued their push as they did the week before, only with more strength.

The top three deals were all ETNs, suggesting that investors are showing a growing appetite for liquidity, sources said.

The week's ETN issuance amounted to $494 million in four deals. It represented 57% of the total volume, up from 29% of the volume seen during the prior week.

The second-largest deal came from JPMorgan Chase & Co., which priced another $142.77 million of its ETNs due May 24, 2024 linked to the volume-weighted average price level of the Alerian MLP index. This add-on brings the total deal size to $904.24 million.

The third ETN contrasted sharply in size to the others. It was brought to market by Credit Suisse AG, Nassau Branch, which priced a $1 million add-on to its 0% ETNs due April 20, 2020 linked to the Cushing 30 MLP index, an energy infrastructure index of master limited partnerships. So far only $57.38 million principal amount of notes has been issued since the ETN's inception on April 13, according to data compiled by Prospect News.

Finally UBS AG, Jersey Branch rolled out $100 million of ETNs linked to the Alerian Natural Gas MLP index. It was the first time the issuer used one of the sub-indexes of the Alerian MLP index for an ETN.

Never too complicated

Sources noted that the flavor of the week was complex, sophisticated products, as if a large portion of the retail market shied away from plain vanilla deals.

"Issuers are increasingly showing complex deals to retail clients. That stuff used to be sold to institutional clients only," a New York sellsider said.

In some cases, complexity meant the use of little-known asset classes or indexes, such as MLP-linked ETNs or volatility. In others, it was seen in large deals linked to algorithm indexes, especially with commodities.

Deutsche Bank AG, London Branch for example priced $27.5 million of 0% market contribution securities due July 19, 2011 based on the performance of the Deutsche Bank Allocator Total Return index, a strategy that aims to offer upside exposure to commodities while limiting potential downside exposure.

Go alternative!

"People want exposure to hard-to-access markets. In commodities, an algorithmic index is a good way to do that," the sellsider said.

The need to diversify was one factor behind the appeal for complex algorithmic strategies and the search for hard-to-access asset classes.

"Financial advisers are told: Go to alternative investments. That leads to algorithm index deals or the new VIX product," a market participant said.

"Complex products may also help investors diversify away from equity. It's the concept of replicating hedge fund performance applied to retail," the sellsider said.

Because some of the algorithm index-linked products enable investors to express more specific views or because they can offset some costs associated with rolling futures contracts, they also tend to be more expensive, sources said.

"Notes on the price of gold or oil don't pay much in fees. You get more with an index and even more with an algorithmic strategy," the sellsider said.

Mixed views

The market participant said that investor sentiment was mixed, which may explain the need to step away from risk and put together defensive strategies.

On the one hand, investors seemed to be less worried about a double-dip recession, this market participant said.

"We're starting to see some of the respected talking heads pointing out some good news. There's more optimism. The July rally has created a sense that maybe things are beginning to turn around," he said.

Correlation: the enemy

On the other hand, this market participant said that investors and also advisers were disappointed by the performance of traditional asset classes. In many cases, he noted, they noticed that wealth had been lost due to high levels of correlation between stocks and bonds, which has made alternative investments all the more attractive.

"Clients want to get away from stocks and bonds because when things go bad, they're highly correlated.

"They want products that are not going to move with the rest of the market. They need downside protection hedges," the market participant said.

Alternative investing typically offered by hedge funds is not always accessible to retail clients.

The market participant suggested that some of the more complex or innovative products enabled investors to get access to non-correlated investments; as such they are likely to be in demand.

"The main question is: How can I further diversify and further limit my risk?"

This market participant said that complexity may be sold to retail investors because many fee-based advisers have discretionary power to put these complex products in their clients' accounts "without having to explain them."

He noted that the advisers themselves are interested in more sophisticated solutions for their clients.

"They are gravitating toward complex products. They think: Hey, plain vanilla didn't do us that much good over the past decade," he said.

Autocallables

Equity decreased last week, amounting to 43% of the volume versus 50% in the previous week.

Within the asset class, the proportion of single-stock-linked deals increased to 10.5% with $90 million versus only 2.7% the week before while indexes declined to 39% from 47%.

Part of the explanation for the appeal of stocks was the resurgence of autocallable deals, the third most popular structure after ETNs and leveraged products, with only three deals but of a decent size. All three transactions were linked to a single stock or exchange-trade fund, not an index, according to data compiled by Prospect News.

"People who anticipate a market downturn see autocallables as good entry points. They short volatility over. If you're right, you make money," the sellsider said.

"Autocallables get done on stocks because it's more volatile. It gives you a higher coupon; it's more attractive," the market participant said.

UBS AG, London Branch issued the largest autocallable deal of the week in a $27.61 million offering of 0% autocallable optimization securities with contingent protection due July 21, 2011 linked to the common stock of Apple Inc. The annualized call premium was 25.4%.

"Apple is not a surprise. They had their earnings this week, and people anticipated stellar results. They got it," the sellsider said.

Apple's fiscal third-quarter earnings soared 78%, a record, according to the company, pushing up the stock 2.8% on Tuesday.

Barclays brought to market another large autocallable deal with $16.22 million of optimization securities with contingent protection due July 21, 2011 linked to the shares of Merck & Co., Inc.

Volatility is positive for autocallable investors, sources said, because the higher the premium sold by the investor, the higher the coupon. Volatility continued to rise last week. However, it decreased earlier this week.

"The risk premium has fallen. The Goldman settlement and the vote on the financial bill have lifted some of the clouds over the industry. Volatility has begun to shift," the sellsider said.

The Dodd-Frank bill received Senate approval on Thursday, and the president signed it into law Wednesday.

Unpopular curves

Another trend was the lack of interest on the part of investors in interest-rate-linked products, with some sources saying that deals did not get done simply because the economics are not there given spread levels.

Morgan Stanley priced the only rate deal in a $5 million issue of six-month Libor range accrual notes.

Rates-linked products did not even make 1% of the market and represented only 4% the week before.

"Rates are not in favor right now. There's not much money to be made on those spreads," the sellsider said. "There's no Fed rate hike. The curve is flattening. It doesn't bode well for those trades."

Yields on the 10-year Treasury have decreased due to rising demand for U.S. government bonds, narrowing the spread between the two-year and the 10-year Treasuries. The 10-year yield fell to 2.93% on Wednesday.

"When the spread is so small, even with leverage, coupons and fees are not that attractive," he said. "People just buy Treasuries."

JPMorgan leads

JPMorgan remained the top agent with a third of the issuance volume sold in 23 deals for $293 million. Half of its sales came from its Alerian ETN deal.

Barclays was No. 2 with $260 million priced in five deals, representing 30% of the total.

UBS maintained its rank among the top three agents, taking the third slot and printing nearly 20% of the volume with $169 million issued in 12 deals. So far this month, UBS is ranked No. 2 with 25% of the issuance, or $377 million. It is behind JPMorgan, which has 30% of the volume for the month.

"Clients want to get away from stocks and bonds because when things go bad, they're highly correlated." - A market participant

"The Goldman settlement and the vote on the financial bill have lifted some of the clouds over the industry. Volatility has begun to shift." - A New York sellsider

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