Oct 17, 2012

Spotlight on Structured Notes: Trends, Product Mix & Underlyings

In this video blog, Numerix Host James Jockle, SVP of Marketing, interviews Tim Mortimer, Managing Director of Structured Edge and Future Value Consultants (FVC) to discuss recent trends in structured notes, including specific product profiles and what's driving issuance. Our guest explores the popularity of leveraged return notes, review notes and bonus structures, their prominence in today's market – and popular underlyings for these products.

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Numerix Video Blog Transcript - Spotlight on Structured Notes: Trends, Product Mix & Underlyings

Jim Jockle (Host): Hi, welcome to Numerix video blog I'm Jim Jockle your host. Today we're talking about Structured Notes. Last week Bloomberg reported that the US note sales in the quarter as going down as volatility falls citing impacts of quantitative easing as well as the uncertainty around November elections. And looking at the product mix nothing's really changed in terms of equity issuance of structured notes dominating about 61.5% of the market with a little bit of an uptick in inflation risk. With me today to talk about product specifics is Tim Mortimer, Managing Director of Structured Edge and FVC, thank you Tim.

Tim Mortimer (Guest): Thank you very much.

Jockle: Tim, looking at Structured Edge.com wanted to talk a little bit about the product mix. So looking at year-over-year clearing reverse convertibles are dominating in terms of number of issuance but moving down the league tables in terms of notionals outstanding and most notably the rise in leveraged return notes this year. Why don't you give us a little bit of a walkthrough of the profile of a leveraged return note and what's facilitating the issuance this year.

Mortimer: So leveraged return notes in the US have been one of the most popular and reliable product type over the last couple of years and is always at or very near the top of issuance. The typical profile is linked to the S&P or maybe the Russell 2000, maturity somewhere between one and two years, some kind of downside protection maybe a ten cent buffer or barrier and then leveraged upsides perhaps two for one upside up to a cap where the pricing determines that. And so it's a good each way bit for investors to capture some upside maybe repair bear market losses or just look to outperform the index in a modest index outgrowth scenario with a cap level set at maybe ten percent per anum which is something they'd be quite happy to end up with as a maximum return and therefore provides upside with some kind of downside protection, so always has validity. The pricing also is always fairly invariant to different pricing situations many products types if volatility moves or interest rate moves they all of a sudden become very attractive or unattractive quite quickly. Because of the nature of the leveraged return note it actually is less sensitive to parameter changes so it's always put out there.

Jockle: In terms of length of maturity what's the general term on these types of notes?

Mortimer: Between one and two years, maybe one and a half years on average.

Jockle: So also fitting in with investments profile of not wanting to be locked up for a long period of time.

Mortimer: Exactly, so the way the product works it doesn't need to be excessively long dated in order to get participation rates such as principal protected return notes have to have long maturity to have them work leveraged ones don't. So you can keep it to a fairly simple structure time some medium term market view and then cast the proceeds and try again.

Jockle: To other moves on the league table year-over-year review notes and bonus structures, again quick overview and what's facilitating the movement of issuance.

Mortimer: Sure, review notes which is popular all over the world, particularly in Europe and Asia that is a product that has some kind of target annual return with the ability for the product to auto call or automatically end if market conditions arrived. Usually that means the index is up after a certain either annual or monthly review date compared to its starting level. It's actually similar to a cross between a leveraged return note and reverse convertible you lock in some target return if conditions arrive then you're free to reinvest. So I would say that really has become more popular because other product types are less compelling at the moment with the way the pricing is.

The bonus structure has always been popular in Europe and for some reason has caught on here (the US) maybe the payoff shape or bonus return which is paid if the market conditions are reasonably favorable with some kind of downside protection built in there. So it's not surprising to see those two there.

Jockle: In terms of underlyings looking at the site clearly the standard list of names that one would expect in indice products two that come up as popular underlyings is Apple, Halliburton. How is that floating in to these types of products?

Mortimer: The reverse convertibles in the US has traditionally been single stock linked, very short dated and with very high coupons. And there linked to different stocks, either from some kind of reverse inquiry process where the client has specified the different stocks it wants to have products linked to or it's just to provide a range of underlyings in a range of different coupons and risk profiles. It also explains why reverse convertibles there's a large number of products out there each of them with a relatively small notional size so as a notional percentage of the market they tend to lag behind the accelerated leveraged return notes.

Apple is always a good choice because consumers and investors identify with it and the volatility and its prospects gives a reasonable return for the risk taken up.

Thanks you very much Tim I appreciate your time, hope to see you in this chair again especially as we come around to the end of the quarter and we can look at performances especially with some of those economic barriers potentially at least being removed or at least worked out knowing where the market will go forward. That will conclude today's video blog I would like again to thank Tim for joining us visit us and chat back with us on twitter or on our blogs on Numerix.com, have a great afternoon.

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