Category Archives: Structured Products

Privately Profitable but Socially Useless – An argument against many Structured Products

In his great book “Between Debt and the Devil“, Adair Turner writes

In fact financial markets when left to free-market forces, can generate activity that is privately profitable but not socially useful. There can be too much finance, too much trading, and too much  market completition.

and

numerous studies have shown that much active asset management adds no additional value but does add significant cost, compared with passive index-linked strategies

This made me think of the fee structure of tracker certificates (structured products) which are set up for a period of 2-4 years and cost* 3% issuing premium and 1.5% p.a. management fee to average over 2% costs, depending on the situation.

That cost is definitely not socially useful and will always reduce the investors performance substantially, espacially in low interest rate environments, like we see now.

It’s my job  to reduce these costs for clients. If you’d like to discuss more, please write me at mz@zuberbuehler-associates.ch .

*these costs were shown to me by an issuer of such a strcutured product tracker certificate

Conduct Problems in Advertising Structured Products in Switzerland

In connection with my recent series of posts highlighting ads by Credit Suisse (Ad 1, Ad 2), Vontobel (Ad 3), Deutsche Bank, Notenstein (Raiffeisen) (Ad 4) pushing structured products such as barrier reverse convertibles, bonus certificates, it was interesting to read this comment from the UK’s Financial Conduct Authority:

Clive Adamson, director of supervision at the regulator, said: “It is particularly important in this sector that advertisements for financial products enable customers to make informed decisions. We think that more can be done to ensure that advertisements are fair, clear and not misleading.” (Guardian.co.uk, May 16th 2014)

This clearly is a problem in the ads I’ve been writing about. The term sheets are often linked to as a by-the-way. I doubt every investor buying the products is reading them. Yet it would be critical.

Also another point is a problem with the ads: the fees and costs of these complex products.

details of fees are either missing or “buried in the terms and conditions”

In todays’ low interest rate environment these products costing maybe 100-200bp (1-2%) are performance destroyers par excellence.

Bonus Certificate CH0239961847 – Advertising on Swiss Newspaper Websites

The latest in the Credit Suisse series of ads for structured products (complex products). The two screenshots below are what you would see just above the headlines on the newspaper website:bonus-zertifikat-2 bonus-zertifikat-1bonus-zertifikat-3

Who are bonus certificates for?

Market Expectation

  • Underlying moving sideways or rising
  • Underlying will not breach barrier during product lifetime

23996184_termsheet_EN  payoff-diagramm-bonus-certificate

If no Barrier Event has occurred, a cash amount equal to the Denomination multiplied by the greater of (a) the Conditional Protection and (b) the sum of (x) the number one (100%) and (y) the Participation multiplied by the difference between (A) the Final Level divided by the Initial Level and (B) the number one (100%), calculated by the Calculation Agent in accordance with the following formula:

bonus-certificate-formula

If a Barrier Event has occurred, and (a) the Final Level is at or above the Initial Level, a cash amount equal to the Denomination multiplied by the sum of (x) the number one (100%) and (y) the Participation multiplied by the difference between (A) the Final Level divided by the Initial Level and (B) the number one (100%), calculated by the Calculation Agent in accordance with the following formula:

bonus-certificate-formula-2

(b) the Final Level is below the Initial Level, a cash amount equal to the Denomination multiplied by the Final Level divided by the Initial Level, calculated by the Calculation Agent in accordance with the following formula:

bonus-certificate-formula-3

Valor 23996184
ISIN CH0239961847
RIC CH23996184=CSZH

Dangers of Bonus Certificates

These graphs show the dangers of (multiple) bonus certificates nicely: Just one of the three underlying equities touched its barrier (Credit Suisse). Roche is up over 85% and Zurich is up 20%. However if you invested 1000 in this product you will loose 20% as Credit Suisse stock is down that much and the bonus certificate turned into a tracker certificate of the underlying that touched its barrier.

dangers-of-bonus-certificates dangers-of-bonus-certificates-2

Swiss Sec. Number / ISIN 12 928 937 / CH0129289374 (WKN: CLA1RJ)
Ticker MBCZR

Non-Ethical Behaviour in Advertising Structured Products

I came across this ad (see below) in the Frankfurter Allgemeine Zeitung today. Vontobel pushing equity linked bonds aka reverse convertible bonds (Aktienanleihen) with coupons of 7% to 8.5%. Most people, who have no advisor protecting their interests, will base their investment decision on the information given in this ad. In this case there is no visual or written information regarding the risk (except the general risk of loss if the issuer goes under). How this can be ethical practice I really have big question marks about. Especially as these ads are provenating from a Swiss Private Bank. These banks were famous for looking after clients interests (or providing solid services). The last decade has seen some of them change their mentality and behaviour towards maximising their profits not their customers and expanding their structured products division or investment banking in general. Such ads bring this point home nicely. It’s not fair, in my opinion, or good practice to not tell someone of the risks involved in an investment. I was taught to underpromise and overdeliver if given a choice. In this ad you are shown the maximum profit, but not the maximum loss. That means the probability of an investor being disappointed is certainly larger than of the other way round. I recently read (also in the FAZ) that the cold calling boiler room operations of our day always want to know whether the prospect has an online trading account and is self directed, because those are the ones that are least likely to spot risk. These kind of ads probably cater to the self directed investors who will not get smart advice. Add to that, that this product will cost you 1-2% and already expires next summer, when you will again have to invest and pay 1-2% through the margin built into the product, and you’ll understand that this is not an advisable long term strategy of maximising your savings or wealth.

vontobel-vkn-vz4b9w-vz4b9x-vz4b91-vz4b92-vz3b98

Aktienanleihen von Vontobel

VZ4B9W, VZ4B9X, VZ4B91, VZ4B92, VZ4B98

www.vontobel-zertifikate.de

 

Credit Suisse – Barrier Reverse Convertibles

Advertising on the website of NZZ.ch for the Barrier Reverse Convertibles of Credit suisse on Danone, L’Oréal and Sanofi in EURO:credit-suisse-barrier-reverse-convertible-7-percent-2 credit-suisse-barrier-reverse-convertible-7-percent

Further information taken from website of Credit Suisse (the flash banner, of which I took screenshots, above linked to it)credit-suisse-barrier-reverse-convertible-7-percent-3

barrier-reverse-convertible-credit-suisse-2

This is my graphical way of showing this product:

payoff-diagram-equity-linked-bond-1

 

“If the value of the Underlyings decreases, the Final Redemption Amount may be substantially lower than the Issue Price. If a Barrier has been reached or breached during the Barrier Observation Period and the Final Level of at least one Underlying is below its Strike on the Final Fixing Date, the potential loss associated with an investment in Complex Products is linked to the negative performance of the Worst-Performing Underlying. Therefore, a total or substantial loss of the amount invested in Complex Products is possible, although any such loss is limited to the amount invested.” Quote Term Sheet

barrier-reverse-convertible-credit-suisse-3

 

barrier-reverse-convertible-credit-suisse-4

 

Valor: 20214804
ISIN: CH0202148042
Ticker: CSAXI

Reason this product can be advertised as in first two images at top:

“The Complex Products do not constitute a collective investment scheme within the meaning of the Swiss Federal Act on Collective Investment Schemes (CISA). Therefore, the Complex Products are not subject to authorisation by the Swiss Financial Market Supervisory Authority (FINMA)  and potential investors do not benefit from the specific investor protection provided under the CISA. The Complex Products are structured products within the meaning of the CISA.”

Structured Products and their Importance to Universal Banks’ Profits

The data below is from a large universal bank in Switzerland. It shows that close to a quarter of the entire banks trading profits come from structured products. The fact they make 300% more money with structured products vs equity trading and equity derivatives tells you a lot about margins and how widespread the use of structured products has become. From a client perspective investing in these instruments this can’t be good news regarding the long run accumulation of returns.

This shows that universal banks tend to be milking clients or that they are proposing using a lot of tax-efficient structures, which tends to pose a problem down the road. In the latter case with tax authorities in the former with clients (if they ever get educated to the effects of structured products on long-term wealth creation). trading-profits-universal-banks

Also see my post on equity linked bonds (and the payoff diagram of the equity linked bond in particular) to see how attractive certain structured products are for the investor, and how attractive for the seller (bank).

 

Equity Linked Bond / Reverse Convertible Bond

Today, reading the F.A.Z, I came across this adequity-linked-bonds for equity linked bonds. These kind of products are interesting as they appeal to people’s need or demand for a high guaranteed percentage return. Everyone knows that current interest rates are close to zero, so you get a lot of regular, even university educated people who are attraced to the high yield shown in the ads (and touted with: “chance for attractive returns, equity bonds with high interest rate on DAX stocks”), but still don’t see the risks associated with them. Their brain has been conditioned to associate a yield and bond price like quote with a safe bond. And who wouldn’t want 7,50 to 8,00% for investing in solid companies such as German automakers. People always need cars.

The role your financial advisor is normally paid for is to recommend good risk-return strategies. Equity linked bonds are rarely such a tool before costs, and even less so after costs. Also they involve you selling short a put. If potential investors saw the phrase: short a put and pocket the premium (for that is what they are doing), they might think twice. The bank guaranteed high nterest rate idea on the other hand hooks the gullible and is therefor the bait. These products get advertised for a simple reason, they allow a higher margin to be pocketed by the firm, in this case Deutsche Bank.

If you look at a payoff diagramm of an equity linked bond payoff-diagram-equity-linked-bond-1you see that your profit is capped and your loss is open ended (apart from interest, i.e. the put premium). Does that sound like a good strategy to pay a bank 100-200bp for? Also note that these products have a time to maturity of 10-14 months. That’s why banks love these products. They simply offer a higher return to them. You are not getting a high enough return as an investor for the risk you’re taking.

In a derivatives lecture my professor pointed this out. One of the young german bankers got pretty aggressive at that point, and very defensive, saying that they were a good deal for the client. The professor said they weren’t. My role as your financial advisor, or of my company, is to make sure you are getting paid for the risks you take and fully aware of the pitfalls.