Structured products: tips for those looking for smoother ride

Wealth managers have been flocking to defensive autocalls amid volatile conditions, but research shows synthetic zeros can provide a higher secondary market price when indexes both rise and fall.

Last year, products with defensive autocall payoffs in particular were popular, as they could provide an early capital payback along with a pre-defined return, even in falling markets.

According to research by Barclays Capital, though, synthetic zero products can potentially provide a high secondary market price when the FTSE significantly pulls away in either direction from its starting level.

Comparing returns

Barclays has compared the possible secondary market prices of an autocall against a synthetic zero. The firm takes, for example, a defensive autocall on the FTSE 100, with an annual hurdle of 87.5% of the starting level and returning 9.3% as a headline rate. Capital is at risk if the index closes below 60% of its initial level on the final valuation date.

This is compared with a synthetic zero on the FTSE 100, with an annual hurdle of 60% of the starting level, with 9.3% locked in for every year the FTSE is 60% of its starting mark. The sum of returns is paid at maturity and capital is at risk if the index closes below 60% of its initial level on the final valuation date.

In these two examples, the only difference is the feature of the early autocall for the first product, which includes the rise of the hurdle in order for the product to redeem early. In this example, Barclays adjusted the hurdle required for a defensive autocall to match the headline terms of a synthetic zero, keeping the potential return the same.

Barclays then modelled the potential secondary market price of each trade, looking one year and two years on from now, and adjusting the level of the FTSE 100.

Taking the scenario that there is four years until maturity and assuming the defensive product autocalls, while the FTSE closes at or above 60% of its starting level for one year prior for the synthetic product, Barclays came up with the following results.

If the FTSE was up 10%, the defensive autocall would return 109.3% versus the synthetic product’s 115.18%.

If the FTSE was flat, the autocall would return 109.3% compared with the synthetic’s 110.62%.

In a falling market, if the FTSE 100 was down 10%, the autocall would have still delivered 109.30%, although the synthetic zero would have a price of 104.59%.

However, if the FTSE was down 20%, the autocall would have a secondary market price of 93.66% versus the synthetic’s 96.37%.

Similarly, if the market was down 30%, the autocall would have a price of 81.12% compared with the synthetic’s 85.48%.

Barclays also looked at another scenario with three years until maturity, assuming the first product is autocalled and the FTSE closed at, or above, 60% of its starting level for two years prior for the synthetic zero. If the FTSE was up 10%, the autocall delivers 118.6% compared with 124.22% for the synthetic product.

In the case that the index was flat, the autocall would still deliver 118.6% compared with the synthetic’s 120.45%.

If the index was down by 10%, the autocall would still return 118.60% compared with 115.12% for the synthetic.

Should the FTSE be down 20%, the autocall would have a secondary market price of 100.75% compared with the synthetic’s 107.7%. If the market was down by 30%, the autocall would have a price of 86.71% compared with the synthetic’s 97.56%.

In both examples, the synthetic zero has a higher secondary market price than the autocall, unless the market was down 10%.

Potential higher returns

Lisa Chaudhuri, vice president at Barclays Capital, said for investors who have the view that the underlying index will fall by a moderate amount during the term of the investment, a defensive autocall may suit their investment purposes better.

‘However, in four out of the five examples above – ie, when the FTSE has pulled away significantly from starting level in either direction – then a synthetic zero investment can potentially deliver a higher secondary market price,’ she added.

Investors should also consider dealing costs that might be incurred with either investment. Whereas autocalls can redeem early, synthetics could be sold back to the issuer, which would mean there is a dealing charge.