The rise of Actively managed certificates
The investment world continues to offer new solutions driven by technological advances such as new platforms, increased competition and ever more challenging markets. These developments serve and are in part demanded by an adviser and investor base seeking new opportunities.
Mutual funds remain the dominant sector in most investment markets worldwide with thousands of individual fund choices across all asset classes and geographic areas. This position has not changed much since the first mutual funds were created nearly a century ago. In the last couple of decades, exchange traded funds (ETFs) have been in close pursuit. ETFs provide the best vehicle to invest in any index-based investment ranging from well-known benchmarks such as the S&P-500 through to thematic indices linked to regions, sectors or classifications such as ESG. ETFs also allow for rather more complex rules-based algorithms such as smart beta and volatility control.
Active versus passive
Though they are not universal properties of either camp, mutual funds are mostly associated with traditional active fund management and ETFs are the mainstay of passive investment. There have always been some exceptions to this “rule” – some mutual funds aim to track mainstream indices (often at hard to justify fee levels and thus under attack from an equivalent ETF) and worse still some mutual funds that call themselves active in reality do not stray far from their benchmarks. (these are known as closet trackers or indexers). From the other side of the fence there has been an increase in the issuance of actively managed ETFs. This goes somewhat against the concept of ETFs as low-cost defined investments but with pressure on fees and the desire to innovate and differentiate there has been an increase in such offerings. ETF providers have sought to capture the benefits of active management within the ETF wrapper with the advantages of liquidity, transparency and a lower cost base.
The way structured products are created and brought to market have elements in common with both mutual funds and ETFs. The main delivery vehicles for structured products are notes, certificates and deposits. The note is the classic debt instrument favoured when an issuer and distributor combine to place product during an offer period. The certificate is the more portable form which is typically listed on an exchange and may have some advantages such as daily or intraday pricing and possibly collateralisation. Deposits are a rather special case and exist only in certain markets where bank deposit taking has a specific treatment and it has been extended to include structured products.
The advantages of certificates
Certificates have gained traction as an attractive route for structured product issuance, particularly in Europe and Asia. This flexible solution is often cheaper, quicker and easier than the traditional note issuance primarily because of the advantage of being listed on an exchange. The structured products markets in Germany, Switzerland and Hong Kong for example have very high numbers of products issued, often in small trade size and needing to get to market quickly. The certificate format scales well to accommodate all these requirements. It gives investors greater comfort and it also assists with regulatory reporting such as those required under MiFID II and PRIIPs.
Given the technology investment that structured product issuers have made in the certificate framework it is a natural extension to use them for other investment offerings and with opportunity to gain further assets under management and earn more fees. It also gives a welcome diversification into a business line outside structured products. Meanwhile there has been an increase in recent years of boutique firms designing new quantitative or thematic strategies looking for a viable way to bring them to market.
Introducing the AMC
The solution which investment banking issuers and others can facilitate this is the actively managed certificate (AMC) which has now developed into a popular solution. The manager will send investment and rebalancing instructions to the issuer of the certificate on a regular basis. Since issuers are already set up to risk manage the hedging of structured products and other instruments, it is easy for them to perform a similar function for an active strategy. The issuer and investment manager will agree details such as fee levels, maximum number and size of trades allowed and time needed to execute orders placed (e.g. T+1 day).
Unless collateralisation is explicitly put in place the certificate will still bear the credit risk of the issuer because that is how such the assets sit on the bank’s balance sheet. However such risk is only on an overnight basis (like for example a simple bank current account) and no term funding or break costs are involved.
Becoming the next fintech story?
The AMC route can allow the boutique investment manager to get strategies out to market cheaper and quicker with the possibility of transitioning to a fund framework later if desired. Because investment banks tend not to be directly in the asset management business there is better alignment for them to facilitate investment managers in this way. A further factor is that many of the more quantitative investment managers have banking backgrounds themselves and are used to the set-up that they can now leverage.
A large number of investment banks already in structured products are now keen providers of the AMC service, particularly those that have invested heavily in digital and fintech. The final piece that connects AMCs back to structured products issuers is the possibility for issuers to offer capital protected or other enhanced versions of an AMC strategy once a track record and commercial success have been built up and the issuer feels confident in managing the hedging risk.
Tags: Algorithms ValuationsA version of this article has also appeared on www.structuredretailproducts.com
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