Unrelenting interest in equity helps volume grow by 15.5% to $12.61 billion for year to date

By Emma Trincal

New York, April 23 - Investors have added equity-based products to their portfolios in a move that exceeds trends seen in recent years, suggesting that the equity rally continues to support the overall issuance volume of structured products, which is up 15.5% for the year to date, according to data compiled by Prospect News and sources commenting on the figures.

Agents as of April 18 had sold $12.61 billion of structured notes, compared with $10.92 billion during the same time last year.

Equity focus

For the year to date, deals linked to equity grew by 24% to $10.52 billion, or 83.4% of the total issued volume, from 78.35% for the same period of last year. Prospect News' "equity" category includes equity indexes, equity exchange-traded funds, baskets of stocks and single stocks.

During the same period in 2012, equity-linked notes amounted to only 72.75% of the market, according to the data.

"It's a very equity-oriented market right now," a distributor said.

"It's not a surprise. Someone asked me last week, what's the sweet spot in the market? Well it's probably equity. That's where the money is going. That's where the returns are.

"Most people believe, and I agree, that we're not going to see another 20% or 30% market jump like last year. But it's probably going to be at least 5% to 10%, which is not bad."

Could do better

A market participant said that growing investor participation in equity is not surprising.

"The year-to-date volume growth is quite impressive. At the same time, the market is much higher. Today, the S&P is 300 points higher than a year ago, or nearly up 20%," he said.

"Since we're continuing to see a substantial rally, you would expect equity to attract a lot of the volume in structured products.

"Besides, equity has always been the dominant part of investors' portfolios in the U.S.

"With the financial crisis and the years that followed, people tried to diversify, but when you look at the performance of the S&P, diversifying away from U.S. equity can hurt your performance substantially. Look at the recent returns of hedge funds and how they've been losing business to long-only strategies.

"It only makes sense you would have a greater participation in the equities. People are already allocated to equities, and they're adding more."

But the overall issuance volume could have been even better this year, he noted.

"The volumes are good. A 15% growth year to date is great. But in a way, given the performance of the S&P, you would expect to do even better than that," he said.

Missed opportunities

"It's a bullish market, and structured notes are offering enticing ways of taking advantage of the rally. But I think our industry has the opportunity to grow even more. It's not necessarily only through small innovations here and there, like different payouts or underlying," he said.

"What we need is more like a fundamental breakthrough in the way products are delivered to the client.

"ETNs were a breakthrough. They've been used a lot to construct clients' portfolios. Our industry has to be more creative in terms of wrappers and ways to deliver the products."

Another key to growth would be for issuers to reach a greater number of independent distributors, such as small broker-dealers, retail banks and registered investment advisers.

"We're seeing an increase in volume, and that's a direct response to the bull market," he said.

"But if we don't expand distribution beyond the wirehouses, we're not fully capitalizing on the opportunities offered by the market. The big firms such as Bank of America, JPMorgan and Morgan Stanley will continue to print large volumes through their internal distribution networks. But we would see much more growth if we were able to expand the use of structured products outside of the big firms.

"I don't see that happening, or I should say, it's happening but only marginally."

This market participant was doubtful that the volume increase this year could be explained by newcomers in the market.

"I don't have numbers showing how much the RIA market has grown from last year, but I doubt that it represents a large chunk of the 15% volume increase. Issuers have not really succeeded in that space. If there was more acceptance of structured products among RIAs, you would hear about it. Issuers would advertise it. The fact that it hasn't been done indicates that we are not seeing major progress in that direction," he said.

Size and economics

Agents have priced 28 offerings in the $50 million or more size this year versus 22 last year.

The total number of deals has grown by 15% this year to 2,635 from 2,308, according to the data.

"The number of deals is not a good indicator of volume," the market participant said.

"It only suggests that issuers are finding better economics when issuing deals. The more templates you have, the cheaper it is to do deals in the future.

"You could have different investors with different preferences. You issue three deals instead of one, but you don't necessarily generate more volume. The number of offerings is more of a test of efficiency rather than an indicator of volume.

"On the other hand, how many big deals you have in any given period of time can make a difference in terms of volume."

Access

Among some of the largest deals seen this year have been so-called "trackers," or delta one notes, which replicate the performance of an underlying on a one-to-one basis with no optionality. As a result, the structures offer no leverage, no downside protection, no return enhancement and no cap.

This category of structure is the fastest-growing this year, increasing 168% to $1.10 billion, or 8.7% of the total, from 3.75% last year.

Among these products was Bank of Montreal's $173.5 million of notes due Jan. 28, 2015 linked to the Raymond James Analysts' Best Picks for 2014. Priced in January, it was the No. 2 deal of the year.

Another such large deal is Goldman Sachs Group, Inc.'s $100 million of notes due May 5, 2015 linked to the Dow Jones-UBS Commodity index, which was issued earlier this month.

"These are access trades," the market participant said.

"Either it's because there is no other specific instrument to get to that index, for instance no ETF, or it's because it can be priced cheaper and made more efficient than the equivalent ETF or ETN.

"Structured notes, including delta one notes, could become a valuable tool for investors, especially if they're priced more efficiently."

Top deals

Last week's volume was modest at $219 million in 105 deals. The market rallied after four days of Nasdaq correction in the prior week, but business was slowed by the Good Friday holiday, sources said.

The prior week, which was the second of the month, saw 133 deals totaling $846 million.

"We've seen fluctuations in the market over the last couple of weeks, but last week was a pretty good rally," the market participant said.

The top three structures were slightly different as none offered leverage.

The largest offering was a digital note brought to market by JPMorgan Chase & Co., $31.52 million of 0% equity digital notes due April 21, 2016 linked to the Euro Stoxx 50 index converted into dollars.

If the index finishes at or above the 90% trigger level, the payout at maturity will be par plus 11.65%. Otherwise, investors will lose 1.1111% for each 1% decline beyond 10%.

The second deal was a short-dated reverse convertible structure with no barrier or buffer, Barclays Bank plc's $19.72 million principal amount of 10% annualized Yield Enhanced Equity Linked Debt Securities due Dec. 26, 2014 linked to the common stock of Gilead Sciences, Inc.

Each note has a face value of $66.51, which was the average execution price per share that an affiliate of Barclays paid to hedge the issuer's obligations under the notes.

Interest is payable monthly.

The payout at maturity will be an amount equal to the volume-weighted average price of Gilead shares on Dec. 19, 2014. The payout is capped at 110% of par and payable in cash or Gilead shares at the issuer's option.

Finally, the third deal was an interest-rate product brought to market by Royal Bank of Canada, $15.78 million of floored floating-rate notes due April 17, 2024. The interest rate is 70% of the 30-year Constant Maturity Swap rate, subject to a minimum interest rate of 2%. Interest is payable quarterly, and the payout at maturity will be par.

Rates-linked notes have seen their volume rise by 78% this year, but their market share remains small at 5.20% of the total.

Leveraged notes with no protection are less in demand this year. Their volume has declined by 21%. Their market share is down to 15% of the total from 22% last year. In contrast, investors are more and more attracted to leveraged products with a barrier or a buffer. Volume in this category is up nearly 14%, and the products make for about 16.5% of the total, the same percentage as last year.

An example last week of this type of deal, and the No. 4 offering, was UBS AG, London Branch's $15.71 million of 0% capped leveraged buffered notes due May 20, 2016 linked to the S&P 500 index.

The leverage factor is 1.3 up to a 20.86% cap. On the downside, investors have a 12.5% geared buffer with a downside leverage factor of 1.1429.

The top agent was JPMorgan with $66 million in 21 deals, or 30% of the total. It was followed by Barclays and RBC.

"It's a very equity-oriented market right now." - A distributor

"What we need is more like a fundamental breakthrough in the way products are delivered to the client." - A market participant

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