The market for ‘structured products’ is experiencing a revival. Given the current prolonged period of low and in many cases negative-yielding assets (particularly in real terms), structured products offer investors innovative ways to seek an uptick in returns while also potentially limiting their risk.
The aftermath of the financial crisis of 07/08, which many blamed on collateralised debt and loan obligation (CDOs and CLOs) markets, had dealt a blow to the structured products market. Unfortunately, the ability for such products to decouple risk from mortgage origination helped fuel loose lending practices. However, it was the underlying asset quality that ultimately harmed investors, not the investment vehicles themselves.
The current revival of the market looks more sustainable and predicated on the ability for structured products to transfer risk in innovative ways. Structured products encompass a wide range of investment vehicles, although all of them have typically been designed to offer investors a customised risk-reward profile. How they achieve that can vary significantly depending on their target market.
Retail structured products typically offer exposure to specific markets while limiting investors’ downside through some form of capital guarantee (typically using a combination of derivatives and/or securities). Different regions tend to display different levels of appetite for these products. In Germany and Switzerland, for example, there is sufficient investor appetite to merit a dedicated structured products exchange. Elsewhere products are typically traded OTC.
Products targeted at institutional or professional investors include fairly straightforward structures such as basket options (an option based on a customised basket of securities) and quantos (where the option and its underlying are priced and settled in different currencies) through to more complex ones such as CLOs and CDOs (as well as CDO2 and CDO3).
Although exchange traded funds are not typically included in the category of structured products, there are many (particularly those that offer leverage and/or inverse returns or achieve bespoke risk/reward profiles through the use of derivatives) that would fit the mould and share some characteristics of a structured product.
Given continued growth in demand from investors for structured products, and potentially higher margin and fee revenues (particularly for bespoke structures), the market opportunities are clear. Yet operational constraints also exist. In terms of the technology supporting this market, few platforms are available that offer the flexibility to accommodate any asset class and any structure. Fewer still offer in-built data management and model integration capabilities.
We have just published a paper detailing some of the technical challenges of supporting structured products, and explaining the platform features required for a successful technology strategy. You can access the research for free here.