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Welcome

SFI Evening Seminar—2 July 2015, SIX ConventionPoint,

Zurich

Unveiling the Results of the First

Comprehensive Study on Structured Products

in Switzerland

SFI Evening Seminar July 2015: 2

Governance

Authors of the study

• Dietmar Maringer, Full Professor, University of Basel.

• Walter Pohl, Researcher—quantitative business administration, University of Zurich.

• Paolo Vanini, Head of Knowledge Transfer, Swiss Finance Institute; Head of Structured

Products, Zürcher Kantonalbank.

Is this acceptable governance for the study?

• No bias in the time period under consideration for the performance study. The start of the

study period coincides with the onset of the most recent global financial crisis, of 2008,

and covers the entire crisis period.

• The analysis of costs is a delicate matter given the very definition of structured products.

Relying on purely academic authorship is likely to produce only low quality results. This

can be observed in many purely academic contributions of recent years.

• Almost impossible to write about realistic investments from a purely academic

perspective.

• The different backgrounds of the authors ensure a system of checks and balances.


Agenda

• Context of the study and our presentation today

• SFI White Paper study results

• Questions & answers


The first comprehensive, representative study of structured

products in Switzerland

Methodology

• Empirical investigation into the Swiss

market.

• Survey conducted among major issuers

to estimate risk management costs.

Sample

• 20,000 and 7,275 products for the

performance and cost analyses,

respectively.

• Product types:

- Barrier reverse convertibles;

- Bonus certificates;

- Capital protection certificates;

- Discount certificates;

- Tracker certificates.

Performance

Investments

Costs

Transparency

Figure 1: Scope of the study.


Performance (I)

Figure 2: Fractions of products with positive

returns.

Main insights

• 2012–2014: Some 80% of structured

products generated positive returns.


Performance (II)

Figure 3: Median performance.

Main insights

• Median returns of between 5% and

15%.

• Best year:

- 2009; most medians were in the

range of 19% to 31%.

• Worst years:

- 2011 (European debt crisis) and

2008 saw large drops in equity

markets.

- These drops also affected

structured products, and they

too had negative medians.

• Capital protection products behave

in a similar way to bonds.


Performance: Barrier reverse convertibles

Figure 4: Barrier reverse convertibles. Median (red line), 25%–75% quantile band (gray area), and

15%–85% quantiles (gray lines).

Main insights

• Return distribution widened in 2011 compared to 2008.

• Return versus risk.


Costs: The problem (I)

Figure 5: The different fee and cost components of a structured product.

¹ IEV = issuer estimated value

Problems

• Costs are known best at the maturity of the products.

• Many components of the costs are not public.

• Risk management is, unlike production and distribution costs, a profit and loss

component of the product borne by the issuer. Price of the complexity and liquidity.

Net margin Production & distribution Risk management

Total expense ratio (TER)

Issuance price

(100%)

Fair price of components

(IEV)¹ (98.5%)

Theoretical (model)

price (97.5%)


Costs: The problem (II)

Risk management

• Theoretical price = Price if all components

of the product (options, stock, funds, etc.)

are priced in a perfect, complete financial

market.

- No market frictions: bid-ask spreads;

- No uncertainty premium for changing

price-sensitive parameters: dividends,

volatilities, and correlations;

- No capital-at-risk charges;

- No gains from risk-free investments at

early redemptions;

- No risk costs for the leverage in some

products.

- Different issuer creditworthiness

means different funding spreads.

Figure 6: Historical 1-year correlation

AUD/CHF from Jan 2012 to Jan 2013

(Bloomberg).


Costs: Risk management (I)

Economics

• Investor buys BRC on ABB with a 75% barrier,

coupon 5%, TtM 1y.

• Spot ABB CHF 20; barrier CHF 15.

Replication

• Investor: Long BRC = Long Bond + Short DIP.

• Trader = - Investor = Zahlungsversprechen.

Pricing

15

20 ABB stock

maturity

Zahlung Kunde 100%

Distribution 0.50%

TER 1.5% Produktion 0.50%

Nettomarge 0.50%

Funding Spread 0.15% Risiko-

management

0.75%

Vola Spread 0.20%

Dividenden

Spread 0.40%


Costs: Risk management (II)

Figure 7: Implied volatility / moneyness

• Investor verkauft die Option, Händler kauft die Option.

• Händler bewertet die Option mit einem Spread von 20

bps, d.h. er zahlt dem Investor weniger, als die Option

zur Mitte wert ist.

• 2 Möglichkeiten

- Händler verkauft die Option direkt an ein anderes

Derivatehaus. Dies kostet den Händler 20 bps. P&L

Optionsgeschäft = 0.

- Händler behält die Option auf dem Buch und bewirtschaftet

die Risiken bis Verfall selber.

Bewirtschaftung durch Händler

• Lokaler P&L Aspekt.

• Globaler P&L Aspekt.

Lokaler P&L Aspekt

• Wert Option = Anzahl ABB Aktien + Andere Anlagen.

• Da: Wert Option heute ≠ Wert Option morgen.

• Händler muss die Anzahl Aktien von Tag zu Tag

ändern – Transaktionskosten.

• 20 bps decken in der Erwartung diese

Transaktionskosten über die Laufzeit decken.


Costs: Risk management (III)

Globaler P&L Aspekt

• Für den Händler entsteht über die gesamte Laufzeit ein P&L aus dem Vergleich der

impliziten und den realisierten Volatilitäten.

• Der Vergleich wird entlang der gesamten Laufzeit aufsummiert. Das Resultat kann

positiv oder negativ sein.

• Händler benötigt deshalb eine View über die Entwicklung der Volatilitäten, d.h. die 20

bps berücksichtigen dies.

• Zudem müssen die 20 bps diese möglichen globalen Verluste decken.

Bemerkung: Es gibt noch weitere Faktoren, welche eine Rolle spielen.

Fazit

• Risikomanagement aus dem Zahlungsversprechen ist eine echte Leistung. Dies hat

auch Produktionskosten wie IT-Infrastruktur, etc.

• Händler steht im Zentrum, in guten wie in schlechten Zeiten.

• Kostentransparenz bei strukturierten Produkten ist definitiv ein komplexeres Thema

als bei der Produktion von iPhones.

• Frage der Materialität: Wie wichtig ist diese detaillierte Kostentransparenz? Es gibt

wichtigere Faktoren für den Anleger, welche verstanden werden sollten.


Costs: The results

Table 1: TERs p.a. for the period April 2012 to April 2015 amounted to:

Tracker certificates versus funds:

• Tracker certificates face similar costs to ETFs.

• Core ETF costs are lower than those of tracker certificates.

• Active tracker certificates seem to have a price advantage over mutual funds.

Product type Number of products 25% quantile 50% quantile 75% quantile

Barrier reverse convertibles 5,477 0.81% 1.71% 2.64%

Bonus certificates 333 0.19% 0.98% 2.22%

Capital protection certificates 48 0.24% 0.58% 1.38%

Discount certificates 1,370 0.92% 1.39% 2.28%

Tracker certificates 47 0.11% 0.32% 0.62%


Costs: The German Study

• Average expected issuer margin,

representative data set.

• It is a function of time; estimated

using linear regression starting

from a snap shot day.

• Risk management figures from

implied market values.

• Secondary market.

• Our view

- Primary market

- Customer view

Figure 8: Definition of costs.

Net margin Production & distribution Risk management

Total expense ratio (TER)

Net margin Production Distribution Risk 1 Risk 2


Investments: Investor behavior and BRC case study (I)

Figure 9: Lowest value of the S&P500 for annual

3y investments (S&P).

Table 2: Barrier events of active BRCs, 2008–2014

(Derivative Partners AG).

¹ Less BRCs with barrier event in the previous year.

Main insights

• Swiss investors prefer to invest in barrier

reverse convertibles on stocks.

• Such investments occur more often when

markets are calm, which is remarkable.

• In turbulent markets investors in such

products receive a higher coupon and/or

can choose a lower barrier for the same

coupon than in normal markets.

• A 50% or lower barrier level would have

led to capital protection in most past

periods.

• A 70% or 80% barrier cannot be

considered to be appropriate for investors

that seek a stock-market-cycle-

independent investment.

Year Number of

active BRCs

Number of

active BRCs¹

Number of

barrier events

Percentage

2008 5,196 5,196 3,115 60%

2009 5,461 3,538 272 8%

2010 7,182 6,968 561 8%

2011 9,839 9,480 3,418 36%

2012 11,498 9,178 371 4%

2013 11,932 11,706 632 5%

2014 10,905 10,700 233 2%


Investments: Investor behavior and BRC case study (II)

Figure 10: Returns of tailor-made BRCs for the investors

who used a tailor-made structured-product platform of a

Swiss structured products issuer.

Main insights

• Average return: 7.7%.

• Products with a positive return: 97.9%.

• Poison pills.

Main insights (see figure on the left)

• Average return: 2.2%.

• Products with a positive return: 77%.


Investments: Opportunities and SNB and ECB Events (I)

• Events occurred. There is no need to hope that something will happen.

• Strong events often distort the markets.

• This simplifies the investment view: Do you believe that markets will return to their normal states?

• There is no need to bet whether markets will increase or decrease; only on whether they will return back to their normal states.

Advantage of events

• Need to be fit to invest; cold-blooded; rational.

Investors

• Need to have a short time-to-market, otherwise opportunities are gone.

• Need to carve out accurately the investment idea—it is all about alpha. Setup for structured products

Investment products


Investments: Opportunities and SNB and ECB Events (II)

Opportunity 1

• SNB and ECB: Stronger CHF against

EUR, and QE boosts European stock

markets.

• Investment idea: Buy for 0.85 CHF a

high quality European stock portfolio

selected by the issuer's research unit.

• Product: Simple tracker certificate.

• Time-to-market: 2 days after the SNB’s

announcement.

• Risks: Strong corrections in European

stock markets.

Opportunity 2

• SNB: Negative performance on

deposits after costs for private clients

and before costs for corporate clients.

High volatility in equity markets.

• Investment idea: Invest in 3 diversified

stock indices (SMI, S&P500,

EUROSTOXX50) with a very low

barrier of, say, 40%. Coupon of 1% to

2% expected.

• Product: BRC (worst of).

• Time-to-market: 1 hour after the SNB’s

announcement.

• Risks: Although market risk is low, the

risk properties are not the same as for

a deposit.



Opportunity 3

• SNB: Almost all Swiss stocks suffered

heavy losses.

• Investment idea: There was no

distinction—on the part of market

participants—between Swiss firms

facing heavy exposure to CHF and

those facing weak exposure.

Overreaction is the market distortion.

• Product: Simple, static tracker

certificate on research-selected stocks.

• Time-to-market: 2 days after the SNB’s

announcement.

• Risks: Second correction in Swiss

equity markets.

Opportunity 4

• SNB: USD 1m rates at 0.2% in cash

markets. USD 1y rates via FX swap

with -0.75% CHF rate at 2.7%. Interest

rate basis is the market distortion.

• Investment idea: Exploit this difference

as a qualified investor with a USD

account.

• Product: FX swap.

• Time-to-market: Immediate.

• Risks: The opportunity does not

converge.



Opportunity 5

• SNB: Negative interest rates YtM of bonds in CHF becomes negative sell.

• Investment idea: Product that is close to bonds—i.e., pays notional amount plus

coupon—with similar risk and a positive YtM.

• Product: Credit linked notes (CLN). Choice from CDS markets for debtors with positive

basis (=market distortion). CLN are:

- More liquid than bonds;

- Have the same debtor risk plus the issuer of CLN note risk;

- Enable investors to have a CHF exposure in a large corporate in Europe or the US

that has no CHF bond outstanding—CLN are a diversification tool for bond

portfolios;

- CLN follow a procedure well defined by the ISDA in cases of default. What happens

to your bond if it defaults?

• Time-to-market: Several days. Limited number of issuers.

• Risks: Irrationality when it comes to credit risk.

All 5 investment opportunities had a positive return year-to-date.


Fragen

Besten Dank für Ihre Aufmerksamkeit.

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