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Why Structured Products from Anand Rathi
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Private & Confidential
Portfolio Re-engineering
Private & Confidential
Uncertainty is here to stay …
Private & Confidential
How have the conventional strategies affected portfolios in the recent times?
Debt Fund category’s average CAGR : 7.59%#
Nifty has generated a CAGR : 3.34%*
Returns from Equity : 12%
Returns from debt : 8%
Returns in the past three years
Expected Returns}
#Income fund Category Average. *As per ACE MF 16 Dec 2013
Large Cap Fund category’s average CAGR : 3.36%*
Private & Confidential
What drives portfolio performance?
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Conventional Portfolio Engineering
*Brinson, Singer & Beebower
Asset Allocation
Security Selection
Investment DecisionsTime Spent
10%
60-70%
20-30%
Impact on Returns
92%
< 5%
< 2%
KEY !!
Market Timing
Private & Confidential
What are the risks that every investor faces?
Short-Run Long-Run
Volatility Inflation
If a portfolio is predominantly debt oriented, though volatility is under control, the purchasing power of the corpus reduces with time. On the other hand, a
significantly growth oriented portfolio has the potential to cause severe mental stress in the short-term.
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How do we decide on Asset Allocation?
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The current chaos indicates that one needs to break
away from conventional strategies to deal with
surprises.
Is it really possible to generate alpha despite the
circumstances
?
Private & Confidential
Key Terms & Specifications
-73.3%
-55.0%
-36.7%
-18.3%
0.0%
18.3%
36.7%
55.0%
73.3%Nifty Returns Product Returns
Maximum returns when final nifty level is above
80% of Initial Fixing Level
Secured Call (55% Coupon)
Tenor 1,260 daysCoupon 55% to 56%Decay Multiple (DM1) 5.075 Decay Multiple (DM2) 1.80
Payoff
If Final Fixing level is at or above 80% of Initial Fixing levelIf the Final Fixing level is at or above 72% and below 80% of Initial Fixing Level
If Final Fixing level is below 72% of Initial Fixing Level
-67.5%
-45.0%
-22.5%
0.0%
22.5%
45.0%
67.5%
90.0%
112.5%Nifty Returns Product Returns
Maximum returns when final nifty level is above
10% of Initial Fixing Level
Tenor 1,217
Maximum Coupon 90% to 92%
Participation Rate 900% to 920%
Contingent Levels 110%
Payoff
If the Final Nifty Level is above the initial level, participation rate of 900% upto first 10% rise in the nifty level after which the coupon is capped at 90%.On the downside there is 1:1 participation i.e. if nifty falls by 1% the principal erodes by 1%.
Key Terms & Specifications
Nifty Accelerator (90% Coupon)
IRR 13.54% IRR 21.22%
Yes … It is possible to generate alpha
Private & Confidential
Advantages of Including passive strategies using Structured Products
No Path Dependency
No Human Intervention
Higher Probability of generating alpha on portfolio
Can be highly customized based on view (range, bullish, bearish or hedge)
Private & Confidential
Having discussed the benefits of passive
strategies, let’s bust a few myths commonly
associated with Structures.
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Myth – 1
Structured Product is a ‘Black Box’
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• It may not be simple, but it is not complex either
• Let us deconstruct with an example
Protected Call Series VIII - ARG/FY2013/JAN/10
• Underlying : Nifty
• Tenor : 1237 days
• Coupon : 61%
• Decay Multiple : 1.75
• Payoff : Max(-100%,Min(Coupon, Coupon + DM * NP))
Private & Confidential
Payoff Chart
-61.00%
-40.67%
-20.33%
0.00%
20.33%
40.67%
61.00%
81.33%
Nifty Returns Product Returns
Payoff Table
Final Nifty Levels Nifty Returns Product Returns
3600 -40.00% -9.00%
3800 -36.67% -3.17%
4000 -33.33% 2.67%
4200 -30.00% 8.50%
4400 -26.67% 14.33%
4600 -23.33% 20.17%
4800 -20.00% 26.00%
5000 -16.67% 31.83%
5200 -13.33% 37.67%
5400 -10.00% 43.50%
5600 -6.67% 49.33%
5800 -3.33% 55.17%
6000 0.00% 61.00%
6200 3.33% 61.00%
6400 6.67% 61.00%
6600 10.00% 61.00%
6800 13.33% 61.00%
7000 16.67% 61.00%
7200 20.00% 61.00%
7400 23.33% 61.00%
7600 26.67% 61.00%
7800 30.00% 61.00%
8000 33.33% 61.00%
8200 36.67% 61.00%
8400 40.00% 61.00%
8600 43.33% 61.00%
8800 46.67% 61.00%
9000 50.00% 61.00%
9200 53.33% 61.00%
9400 56.67% 61.00%
9600 60.00% 61.00%
9800 63.33% 61.00%
10000 66.67% 61.00%
*Assuming initial nifty of 6000
• Initial investment : Rs. 100Park the initial investment at 11.25% p.a.Returns after 1237 days: Rs. 144
• Earn premium by selling 1.75 PUTS at Rs. 11Park the premium amount at 11.25% p.a.Return after 1237 days : Rs. 17
• Total Inflow at maturity: Rs. 161
Construction
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Product Strategy & Corresponding Payout
Final Nifty Levels in %
Payout of Step 1
Payout of Step 2
Payout of Step 3
Payout of Step 4
Net Payout
-40% 144 -40 -30.00 17 91.00
-30% 144 -30 -22.50 17 108.50
-25% 144 -25 -18.75 17 117.25
-20% 144 -20 -15.00 17 126.00
-15% 144 -15 -11.25 17 134.75
-10% 144 -10 -7.50 17 143.50
-5% 144 -5 -3.75 17 152.25
0% 144 0 0.00 17 161.00
5% 144 0 0.00 17 161.00
10% 144 0 0.00 17 161.00
15% 144 0 0.00 17 161.00
20% 144 0 0.00 17 161.00
25% 144 0 0.00 17 161.00
Product Strategy
Step 1
Invest principle amount Rs.100
with treasury @11.25% for 1237
days which will grow to Rs.144
Step 2
Sell Insurance, on Nifty, which
provides 100% coverage to Mr. X
and earn Rs 6.29 premium
Step 3
Sell Insurance, on Nifty, which
provides 75% coverage to Mr. Y
and earn Rs 4.71 premium i.e.
Total premium earned is Rs.11
Step 4
Invest total premium of Rs.11 with
treasury @11.25% for 1237 days
which will grow to Rs.17
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Myth – 2
Structured Product is an ‘Alternate Asset Class’
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• Structured product is not a product, it is a platform or a wrapper like amutual fund
• Structured Product can form a part of the core portfolio based on theunderlying features of the product
• For example, high participation based products can be part of theequity portfolio where as fixed coupon products can be plugged in thedebt portion of the portfolio
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Myth - 3
Structured Products ‘Never Make Money’
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Structure NameTenure
(Months)NIFTY
ReturnsSP
ReturnReturns Alpha
CouponProduct Features
RELIGARE PMS APF (Barclays) 36 61.6% 114% 52% – 175% PR product
Milestone NIFTY Linked SPS LVIII (Macquarie INE796L07258)
16 19.31% 46.74% 27% –Coupon 8% plus 200% PR
product with contingent & KO
Milestone NIFTY Linked LXV(Macquarie INE796L07274)
16 18.08% 39.61% 22% –Coupon 14% plus 150% PR
product with contingent & KO
MILESTONE NIFTY LINKED SPS VII (ECL)
24 -1% 18% 19% 18%18% Fixed coupon with 40% PR
and 100% downside PP
Milestone NIFTY Linked SPS L (INE804I07BN8)
18 4.56% 22.00% 17% –Coupon of 22% with downside
contingent of 75%
Religare PMS SPS VI (ECL) 15 3% 21% 17% 16.50% 21% auto call coupon
MILESTONE GOLD LINKED SPS I (Edelweiss)
24–
51.46%– – 90% PR with 100% downside
protection
Actual Performance of Some of the Structured Products
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Myth – 4
Structured Products are ‘Very Risky’
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• The approximate size of Structured Products market in India today isUS$ 4 Billion*
• Not a single default or delay by any issuer till date, since the inceptionof structured products in India
*Source - http://www.risk.net/structured-products/news/2135331/-net-worth-investors-india-alternative-assets-report
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Myth - 5
‘Rating’ is the only criteria
.
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Perceived Risk Actual Risk
• Rating generally reflects the perceived
risk of the issuer.
• Rating agencies have set parameters for
rating an issuer. While it is an important
criteria, it cannot be the only criteria for
evaluating the risk.
Actual risk of the issuer can be assessed
by considering various aspects:
• Due diligence on balance sheet
• Line of business activity
• Parentage
• Understand the risk mitigating
measures of the options desk
(% of OTC contracts..etc).
Issuer Risk Assessment
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Myth – 6
‘Principal Protection’ is a must
Private & Confidential
• 100% Principal Protection may not be necessary on all Structure Products
• Non Principal Protected or Partial Principal protected products can havebetter Risk Reward payoff
3 Years Rolling Returns of nifty from 2003 to 2013 suggest that, Nifty has never dropped below 20% in any of the 3631 observations.
-50.00%
0.00%
50.00%
100.00%
150.00%
200.00%
250.00%
300.00%
350.00%3 Years Nifty Rolling Returns for the past 10 Years
Redemption dates
Re
turn
s (
%)
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Myth – 7
‘Costly Affair’ & ‘No Exit Mechanism’
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Cheaper Investment Option
• One time 0.5% to 3% fees against 2% management fees annuallycharged by Mutual Funds.
Easy Exit Mechanism
• Unwind quotes are available almost on daily basis
Private & Confidential
Thank You
Disclaimer:-This report has been issued by Anand Rathi Financial Services Limited (ARFSL), which is regulated by SEBI. The information herein was obtained from
various sources; we do not guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an
offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments"). ARFSL and its affiliates may trade for
their own accounts as market maker / jobber and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side of public
orders. ARFSL, its affiliates, directors, officers, and employees may have a long or short position in any securities of this issuer(s) or in related investments. ARFSL or
its affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this
report. This research report is prepared for private circulation. It does not have regard to the specific investment objectives, financial situation and the particular needs
of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment
strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that
income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Past performance is not necessarily a guide to future
performance. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report.