A new class of financial products has caught the fancy of Indian investors. These are structured products, so named because they are designed in such a way that if the stock market falls sharply, investors at least protect their original investment.
A large number of wealth managers have started offering such products to their
clients, high net-worth individuals looking to diversify their portfolios. HSBC Asset Management (India) Pvt Ltd and JM Financial Ltd are the latest entrants in this space. The portfolio management services (PMS) division of mutual fund (MF) companies and wealth managers such as Benchmark Asset Management, ICICI Prudential Asset Management, DSP Merrill Lynch, Kotak Mahindra Group and HDFC Asset Management have been active in this market.
Getting prominence: Conservative investors, who typically bought RBI relief bonds, have developed a liking for structured products. Also, the number of companies offering such products is on the rise.
Structured products have been in India for around three years, but they have become popular over the past few months, a period when the stock market has turned volatile. The money invested in the 13 structured products currently available in the market is estimated at Rs2,000-2,500 crore by executives in companies offering such products.
Nature of the products
While they limit losses, structured products do not promise the same returns conventional ones do. However, other investment avenues such as equity or plain vanilla equity funds, do not limit losses.
These products use time-tested quantitative models and mathematical formulae, which indicate the proportion that investments in stocks and safe avenues, such as bonds and cash, should have in a portfolio at various market levels. The product may also specify that if the value of the portfolio falls below a certain floor level, the capital guarantee clause will set in to ensure that the investor’s capital is protected.
However, such downside protection can come at a steep price in the form of loads and expenses that are often ignored by the investors. These products may charge initial subscription fees, annual recurring expenses and an exit load for investors wanting to exit before the scheme’s tenure ends. Expenses could go up to as high as 5-6% of the investment in some cases.
Most structured products currently available in the market use two such models: Constant Proportion Portfolio Insurance (CPPI) and Dynamic Portfolio Insurance (DPI). In CPPI, the proportion of assets to be kept in stocks is decided by a multiplier, which is fixed; in DPI, this multiplier is reviewed actively and hence the proportion of assets in stocks changes. HSBC Asset Management’s Capital Guard Portfolio uses the DPI method to re-balance assets between stocks and cash. The company has tied up with Sinopia Asset Management (Asia Pacific) Ltd to advice it on managing the scheme. The scheme also carries 100% guarantee from HSBC Bank Plc. at the end of the four-year tenure.
Within these two methods, there can be small variations.
JM Financial’s Triple AAAce Scheme, for instance, will invest in equity funds for five years and provide investors at least 85% of the maximum peak value of the underlying portfolio of funds, at the time of maturity. It has tied up with Societe Generale Asset Management and has been rated by Crisil Ltd, a subsidiary of ratings agency Standard & Poor’s.
In the US, where structured products have existed for a long time, they accounted for around $64 billion (Rs2.97 trillion then) of assets in 2006; the number is expected to touch $100 billion in 2007, according to an association of firms offering structured products, based in New York.
In India, Crisil has thus far rated 35 structured products being offered both by MFs and PMS companies, which means that the market could soon see a spate of launches.
Executives in companies offering structured products say that the steady rise in the Indian markets over the past few years has made these products attractive for both new and existing stock market investors. “With markets giving phenomenal returns, those who didn’t join in earlier are keen on participating now, but don’t want full exposure to stocks. Secondly, volatile markets have made the existing investors a bit cautious and they want some downside protection for their stock investments,” said Sai Tampi, senior vice-president and head of PMS at HSBC Asset Management (India).
Besides the need for protection, it’s also the need for alternative ways of investing in stocks that is driving the growth of these products. Conservative investors, who typically bought relief bonds issued by the Reserve Bank of India, have developed a liking for structured products. Not only have investors embraced this product; the number of companies offering such products is also on the rise, according to Rajan Mehta, executive director, Benchmark Asset Management Co. Pvt. Ltd, the company which launched the first structured product in India, in 2004.
“For a long time, Indian investors could only go long on stocks and they had limited investing options,” said Shahzad Madon, head of PMS at ICICI Prudential Asset Management Co. Ltd. The market for such products is bound to register sharp growth, he added.
While most firms offering structured products have targeted high net-worth individuals with savings of Rs50 lakh or more, retail banks such as ICICI Bank that usually advice clients with savings of Rs5-15 lakh, have also entered this space. So structured products are now accessible to a wider base of investors.
For its new product, HSBC Asset Management has lowered the minimum ticket size from Rs50 lakh-1 crore to Rs25 lakh. “If investors have to use this product as an asset allocation tool, we can’t expect them to shell out 50-100% of their assets. To ensure that it appeals to a large section of the population, we have brought down the minimum ticket size” said Tampi of HSBC Asset Management. However, some executives in the business do not think that structured products will ever have mass appeal. “The target audience for such products is fairly limited. Issuers of structured products usually do small tranches for a limited number of clients,” said Milind Barve, managing director of HDFC Asset Management Co. Ltd.
More cos, more products
New companies are looking to enter the space with even brokerages such as Religare Enterprises firming up plans to offer structured products.
Equity-linked debentures are another structured product gaining currency. In this, a debenture is issued by a non-banking finance company (NBFC). Unlike a normal debenture, where the interest rate or the coupon rate is fixed, in these debentures, the interest rate depends on an underlying basket of stocks. These stocks could be those identified by the asset manager or they could be stocks in the National Stock Exchange’s S&P CNX Nifty Index. For instance, a debenture could carry an auto-trigger clause, whereby if the selected set of stocks rises by 100-105% in the prescribed period, then a pre-determined interest rate of 20% per annum will be paid to the investors on a proportionate basis (if the stocks reach the trigger in six months, then the interest will be paid for such period). Such debentures are currently being issued by the non-banking finance arms of Citibank, DSP Merrill Lynch Ltd and Kotak Mahindra Group. Barclays Capital Plc. that has recently set up its banking operations in the country, also plans to offer equity-linked structured debentures through its NBFC, Rank Investment and Credit Ltd. The company will seek investment guidance from its global offices while structuring the payout on these debentures. By issuing such debentures, NBFCs also get a chance to diversify their funding sources.
Once an NBFC issues the debentures, the PMS firm or the wealth management firm creates the structure of the debenture. The final product is sold out to their clients. Not all firms will create the product on their own; usually, many will market or distribute the product created by others.
Similarly, only some firms may develop the CPPI/DPI-based products, with other firms remaining content to distribute such offerings. The rest of them could also market it to their clients. Benchmark Asset Management has launched 12 series of structured debenture portfolios. ICICI Prudential Asset Management’s PMS wing has, since 2006, launched five series of debentures and three other structured products. DSP Merrill Lynch launched a scheme that bundled a portfolio of infrastructure stocks along with a debt component.