Disruption and financial innovation seems to be popping everywhere – except that is in the slightly peculiar world of retail structured products. I say peculiar because although this is a space that relies upon financial engineering, it hasn’t actually seen much innovation in over a decade. In fact, a cynic could argue that precisely because this market has been so innovative in the past, most the existing players are now happy to stay boring and conservative. Possibly with good reason because too many innovative solutions in the past have ended up falling foul of the regulators after financial meltdowns and scandals. As a consequence perhaps, many well-established players in this space are happy to sit tight selling a fairly short list of standard products. Top of that list is inevitably the good old autocall or kick out plan. It ticks lots of the boxes for many investors seeking a defined return with some upside and some downside protection. My guess is that the vast majority of structured products sold via IFAs are indeed these autocalls and frankly bar the odd 10 year plan, nothing much has changed in this market for ten years. Next up on that list is probably the accelerated growth product, which usually consists of an upside option with a cap on total returns – make 10 times the return on the FTSE upto XX%. Lastly, we have the odd income-based product, although these are in reality the tiny long tail of products compared to the first two.
Stepping back from the product end of innovation – or lack of it I should say – what’s striking is how little change there’s been with the major providers or the distribution channels. Maybe that’s a good thing and after a few years of scandal and crisis, the SP space has now stabilised, rebuilt its reputation and refocused on just doing a few small things well.
But my guess is that sooner or later the world of financial disruption and innovation will catch up with the structured products industry, especially for retail and advisers. The force for change will probably come via tracker or passive fund structures, and especially ETFs and ETNs. I already know of a few innovative SP providers thinking around the smart beta opportunity and equally I know of more than a few ETF providers thinking long and hard about how they can build a tracker product that looks and feels more like a structured product.
We’ve already seen the first products begin to emerge, curiously in the US. I say that because the US is arguably a bit behind the European market for SPs, with the regulators generally taking a dim view of these structures. Also, synthetic products are also not permitted in the US ETF space, which rather limits the room for manoeuvre.
But that’s not stopped new outfits carving out an interesting niche. First and foremost we have Metaurus which was set up by a cohort of ex-investment bank structured products folk. Its recently launched a duo of products that splits up the total return from investing in equities into a (dividend based) income fund and a capital gains based, price returns offering. In a recent FTfm article, I wondered whether this was all a bit too close for comfort to the split cap funds of old but in truth the two Metaurus ETFs look and fell a lot more like structured products that trade on exchange. Crucially though both ETFs have exchange listed underlying product structures.
Metaurus aren’t the only US newbies looking to corner this space. News and analysis website www.etfstream.com report that Powershares founder Bruce Bond is back in play with a new issuer called Innovator Capital Management. It’s opening gambit – you guessed it defined return Etfs. More on this at the bottom of this blog.
My guess is that more than a few existing ETF providers are now beginning to scratch their heads about how they build a better version of a listed structured product – following in the footsteps of both Metaurus and Bruce Bond. I think defined return will be an interesting core area i.e giving beta style returns with some protection on the downside. I think a la Metaurus you’ll also see the various components of total equity returns broken down into different tracker funds. Lastly, I think we’ll see next generation smart beta products emerge which combine elements of downside protection, and volatility control.
Once we step outside of the ETF product features we might also see more general innovations. What about more multi-asset solutions packaged up more like a defined return? Or smart beta versions of an absolute returns strategy i.e using technical measures such as the 20/200 day moving average to signal switching between asset classes? Or what about wrapping ETFs into retail structured products to help reduce the costs.
Anyway, here’s that ETF Stream story from David Tuckwell in more detail……
Bruce Bond launches defined outcome ETFs
PowerShares founder Bruce Bond and his partner in crime John Southard are back in the ETF industry with new issuer Innovator Capital Management. As part of their opening foray, Bond and Southard are listing a family of “defined outcome” ETFs based on the S&P 500.
“Defined outcome” – is a type of investment strategy that uses options to ensure certain outcomes. But usually requires investors to stay locked in for a certain period. The new products are:
- Innovator S&P 500 Enhance and 10% Shield Strategy ETF (EAPR)
- Innovator S&P 500 Ultra Strategy ETF (UAPR)
EAPR matches the S&P 500 price index (excludes dividends) in the good times while providing 10% downside protection in the bad. The downside protection allows investors to lose absolutely nothing if the S&P drops by 10% or less – provided they stay invested for 12 months. But it also caps how much they can gain. It does this by buying options, and the “interplay” of options helps produce the desired returns, the prospectus says.
UAPR will have the simpler mandate of just trying to beat the S&P Price Index in the good times while merely matching it in the bad. UAPR also presumes a 12 month investment period and the upside is subject to a cap, which will vary from year to year.
Analysis – ETFs to disrupt structured product
The ETF industry is much bigger and better recognised than in Bond’s heyday in 2006 but there’s also more competition. Today, there’s no money to be made in plain vanilla ETFs, meaning those brave enough to enter the industry have to offer something truly different – and often do the educational work that comes with it. As the first, in many ways, to offer smart beta ETFs, Bond is better placed than almost anyone to hazard a guess at what new idea might work. And defined outcome ETFs are truly new.
In what commentary exists so far, some have asked whether these new products, which look like annuities but without the lockups or cost, are intended to disrupt the insurance industry. But disrupting the insurance industry seems unlikely. Another guess might be that they’re intended to disrupt the structured product space. European banks have been offering this type of structured product for a while (the certificates industry in Germany has been going for years), but they aren’t quite available in the US like they are in Europe.
It will be interesting to see how well these funds go about raking in assets. The US ETF market is heavily retail driven but these types of products are mostly unfamiliar to the US retail market, suggests a lot of educational legwork will be needed to get these products bought and sold. Then again, Mr Bond has been here before and succeeded.