SRP Apac 2023: asset class rotation and emergence of hedge fund plays

The SRP APAC Conference 2023 kicked off with three panellists from private banks sharing the strategy shift amid rising interest rates on 3 May.

It is the upward trajectory in interest rates that has impacted the structured products landscape the most, according to Rohit Jaisingh, head of capital markets products at DBS Bank, adding that the climb has led to risk de-escalation close to a risk-off mode.

"This means that the momentum of equity structure products, which were the key driver of our business, has stalled," said Jaisingh. "Inflation is persistent at high levels and corporate earnings are under some pressure. So, the outlook for equities is still unclear."

With implied volatilities coming off, we've been encouraging our clients to buy some downside protection on their portfolios - Rohit Jaising, DBS Bank

According to Jaisingh, interest rate hikes has enabled the private banking clients at DBS to pivot to interest rates-linked products as a result of the inverted yield curve and low risk propensities. "We have seen a lot of interest in rate-linked products like step-up notes, capped and floored floaters with or without credit overlays,” he said.

In addition, the 'near cash structure products', as they are known at DBS Bank, have gained traction with credit-linked notes (CLNs) that track Monetary Authority of Singapore (MAS) treasury bills frontrunning the trend.

On the underlying side, Jaisingh noted that the Bridgewater global macro strategies and DBS Bank's flagship portfolios, including the DBS Barbell Income Fund, was brought to the market through structured products in Q1 23 to complement stock dispersion strategies.

"With implied volatilities coming off, we've been encouraging our clients to buy some downside protection on their portfolios," he said. "In essence, what has happened over the last couple of years is that we have seen this asset class rotation."

At DBS Private Bank, the asset class split for equity, rate and FXlinked structured products has shifted to 40/30/30 from 60/20/20 based on the issuance volume from 2021. "This is a pretty significant shift as far as our business is concerned," said Jaisingh.

In contrast, the asset class split for equity and non-equity was 90/10 for structured products traded at Nomura's International Wealth Management before Q1 2022, featuring autocallables, reverse convertibles, accumulators and decumulators, according to Aditya Sehgal, head of capital market solutions at the Japanese bank.

"The impact of [interest rate hikes] forced us very aggressively to move in a direction of looking at other products within the portfolio that can complement a diversified the overall offering," said Sehgal, adding that principal-protected participation products have also been in focus over the last 12 months.Investors essentially want as much unlimited upside as possible and as little downside as possible through participation products, which has become feasible in the current rates environment, said Sehgal.

"What we've been pushing or focusing our participation products on are the high beta, small cap type of names," he said. "With just three, four or five months of high velocity, you essentially want to get your principal return."

At HSBC Private Banking & Wealth (PBW), investors began to show "massive interest" in interest rates-linked structured products from 2022 until equities "came back" towards the end of the year contributing to 65% of the trading flow in Q1 2023, according to Ishan Sarkar, head of capital markets, Southeast Asia at HSBC

"When it comes to equity-linked structured products, we generally talk about fixed coupon notes (FCNs), equity-linked notes (ELNs), dual currency notes (DCNs), accumulators and decumulators. What was different this time was that clients actually used the higher interest rate to express their directional view," said Sarkar.

Participation notes with principal protection have been increasingly used to implement high-conviction themes like China's re-opening from Covid-19 on back of stock baskets. The demand boils down to the fact that there is a lot of risk reduction. But at the same time, there is "a bit of optimism" in certain market geographically.

"When the market outlook is unclear, what we do is to take a step back and look at our strategic asset allocation," said Sarkar. “Hedge funds have been a favoured underlier choice since early 2022, and structured products linked to hedge funds are very new in Asia.”

At HSBC PBW, the house view is that clients need to diversify their investments, such as by allocating 10% to 15% to alternatives. With a structured product where investors buy a call option on a basket of hedge funds or a single hedge fund, they benefit from downside protection while still participates on the underliers, according to Sarkar.

"Given the challenges we have in the market, the innovation is structured products continue to happen," he said.