FEATURE | Q&A
Buy-side view: taking advantage of the transfer of the risk from issuers’ books onto investors Fortem Capital has positioned its fund of structured products and derivatives as a strategy that can take advantage of pricing dislocations and fulfil multiple asset allocation scenarios.
the short term, if there is a significant equity market sell off like we saw in March 2020, then these products can’t capture a lot of that downdraft,” says Senior. What would you say are the main developments in the structured products market since the market crash of 2020? Ed Senior: It's well known that March 2020 was the month when Covid really kicked in with regards to equity markets. Some of the indices including the S&P500, FTSE100, and Eurostoxx were down in excess of 35%, and with that, you saw massive spikes in implied volatilities as well as dividends within the derivative space getting smashed considerably also due to Covid and company earnings concerns.
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RP spoke to Ed Senior (pictured), managing partner at the UK firm, to discuss how the fund has performed over the last couple of years and the latest developments in the structured products market. The Fortem Progressive Growth Fund aims at providing a defensive equity allocation shorter term and / or an absolute return like profile with a target of 6-7% over the medium to longer term.
“You may not get the six to seven percent exactly every year (could be more or less), but over the medium to long term, that's what the fund will deliver, whilst also exhibiting around about 50% of the volatility of the underlying equities, to which they're linked, unless there is a 40-50% equity market sell off over six years, in which case the fund will perform like equities,” he says. “And at the same time, we ensure that the credit risk within the fund is limited to investment grade sovereign bonds.” That’s another advantage of the fund - when you buy an individual structured product you take the credit risk of the issuer, but if you buy it in the sense of a diversified portfolio in a fund, the credit exposure is that of government sovereign debt. “The only specific critique against structured products is that over
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As a result of that, we have seen innovation in payoffs and banks moving to mitigate some of the risks associated with structured products. That’s key for a firm like Fortem, which provides structured products individually and via funds. We effectively work with banks and harness some of those cost mitigations or innovations and pass those benefits onto the end investor. How does the fund take advantage of structured products? Ed Senior: The two main things we look into with regards to structured products is discontinuity risk which comes from the digital payoff that's inherent within the structure of products; and the correlation risk which comes from the fact that a lot of these products are linked to basket of indices or stocks, and have worst-of payoff structures. That means that the banks carry correlation risk on their books. In order to mitigate that risk banks are looking at the capital preservation element (soft protection) on an ongoing basis during the life of the product rather than only observing it at maturity. This means that every day, if the underlying index or worst performing underlying index is above a predefined barrier the product locks in a small amount of capital preservation and that is observed trough the life of the product. That works for the client potentially because you have fewer payoff swings in terms of the value of the last day (150%) and the value when the initial investment was made (50%), and also for the banks as they mitigate some of this significant discontinuity risk at maturity.
