The global health and economic situation of 2020 has profoundly changed the world we live in. As a consequence of the economic damage that is expected in both the short and longer term equity markets have been on a rollercoaster ride. They showed dramatic falls in March and have exhibited high levels of volatility since then as markets try to assess the updated situation in terms of continued health measures, business stability and employment levels, and international trade and demand.
For many structured product investors index linked products continue to represent the most natural solution, but any big moves across the market give an opportunity for more tactical product issuance, as we have also seen this year.
Perils of stock picking
Stock picking is notoriously difficult even for seasoned equity managers. When we transfer that discipline to structured products it gets even more complicated. Apart from the fundamental question of being able to identify which stocks have good prospects, there are other issues that need to be considered. Firstly, the time to get a product to market is important in order to exploit any opportunity but sufficient time must be allowed for marketing and to maintain compliant sales processes. In equity based investing market timing is a simple “buy-low sell-high” game, however because structured products have a variety of risk profiles, the emphasis is not always about growth but for structures such as Reverse Convertibles or Auto-calls it is more about finding stocks that will achieve certain targets such as moving sideways or better or avoiding breaching a downside barrier.
In equities it is possible to put on a position with a view to exiting when profits have been made or when the market assessment changes. In structured products, most products are designed to be held to maturity and so typically the product must be tailored with this fixed maturity in mind. This means that the product should have some margin for error to allow for timing effects. Additionally, the maturity of products that try to time the market tend to be not more than one year long, because having a strong view beyond that horizon is harder. Therefore the product construction is usually a yield enhancing or leveraged return structure, because all capital protected products struggle in with maturities of that length.
When trying to time markets there are two diametrically opposed schools of thought, the first is to pick stocks that have fallen but which are expected to stabilise or rebound. This means that products will strike at lower values than would have been possible before and can profit from any recovery. The second philosophy is to pick those which have already demonstrated some growth but which are expected to show further gains. In equity terms these two strategies are equivalent to value and momentum investing respectively. Both have their followers, and both can claim successes in the past.
In the wake of any economic changes and corresponding market moves strategists often debate whether we can expect a return to the previous position or whether we have entered a new paradigm.
A new paradigm or game up?
In 2020 there has been much talk of a move towards a technology and remote based economy for years to come and there have been a raft of products seeking to profit from this fundamental shift. According to data from www.structuredretailproducts.com, the six stocks with the highest sales volumes in 2020 to date are in order from the highest first: Amazon, Apple, Netflix, Microsoft, Visa and Alphabet (parent of Google). These stocks are perennial market favourites but they all stand to gain further from the new measures the world has been forced to adopt. Correspondingly we have also seen many airlines, leisure and travel firms and some Industrials suffer.
Of these six stocks, four have shown strong gains in the period 1 February to 15 June 2020, with Amazon the highest at 28%. Only Alphabet (flat) and Visa (down 4%) have failed to rise so far. By contrast, the Nasdaq is up 8% and the S&P-500 down 5% over the same period.
In conclusion, these stocks being the most popular underlyings by sales volume could be expected to continue for the foreseeable future to profit from prospects created by the way the world economy will now operate. These stocks have already shown some growth but may well have room to grow, particularly suited to structures that are not overly bullish by construction.