Smart beta and equity factor investing did rely on fundamentals rather than on market imbalances

approaches seeking for example carry through alpha, or defensive profiles.”

Issuers are well positioned to identify structural markets imbalances and dislocations, which create robust, structural premia, that can be wrapped into investable strategies.

Hedge fund like returns

According to Gimenes, some of the arbitrage strategies SGI has developed include tail risk hedges which are defensive, aiming at ‘convex’ profiles in very severe downturns like the ones we saw in 2008 and 2020.

“There are similarities to the approach implemented by some hedge funds, which are trying to capture the imbalances and market opportunities through relative value positioning,” he said.

“Some QIS strategies implement a similar approach, when the premia at stake can be implemented in a systematic manner. QIS range also explores broader market segments as it offers access to longer term horizon, hedging strategies beyond pure alpha generation, etc.”

Liquidity issues

When it comes to risk management and hedging products linked to new custom underlyings, Gimenes noted that everything relating to delta one exposure does not raise volatility risk management issues “because the strategies are built in a way that are properly replicable by the issuer”.

“There is no convexity at stake which means that the risk management is more this of a classical equity portfolio,” he said. “This is very familiar to delta one traders, but the structured products space is different and does raise some additional challenges.”

ESG is a good example of trading desks having to deal with lower liquidity in underlyings used in the structured products market.

“Every strategy we build must be replicable from a risk management standpoint but it is true that some strategies that are deployed via delta one products are hard to translate efficiently from a pricing perspective into structured products, which imply more dynamic hedging process,” said Gimenes.

“Sometimes we must somehow restrict ourselves to a subset of assets and underlyings that are liquid enough for us to hedge properly. On top the individual hedge, we make sure that there is a reasonable risk management product by product.”

Book diversification

The second critical layer investment banks apply to manage liquidity risk is diversification at a trading book level which also comes from investor demand specially for those issuers with a global reach.

“The structured products market has evolved towards tailormade products and this brings challenges compared to managing an S&P500 or EuroStoxx 50 only book,” said Gimenes.

“For this business to be sustainable it must be done properly. Education and transparency remain very important aspects of this market and product governance is also a must.

Mifid has helped to normalise product governance at a manufacturer and distribution levels. However, it is important that some of the more complex structures are offered to sophisticated investors only and do not end up in the wrong hands.

For instance, SGI’s QIS and discretionary portfolio strategies must be aligned to the right target market, said Gimenes.

“This is a very important aspect of governance,” he concluded. “The market has made significant improvements on disclosure and regulation has established a standardised sales and marketing processes, which is good because issuers and manufacturers must ensure that the right product end up in the hands of the right client and that investors have enough information to make an informed decision when they invest in these products. That's crucial.”