Structured Products
Canadian Annual Derivatives Conference
August 17th -19th 2005
Why Structured Products?
Access to strategies unavailable to Mutual Funds
Repackaging of securities
Tax benefits
Access to offshore securities and funds
Access to enhanced manager ‘tool kit’short sellingoptionsderivativesLeverage
Exposure to previously unattainable investmentsOffshore propertyHedge Funds
Forms of Structured Products
Listed:Income TrustsSplit Share CorporationsClosed End FundsFlow through LP’sExchange Traded Funds (ETF’s)
Unlisted:Market linked instruments
Listed Structured Products
Ending Dec 2004: -$41.5 Billion-3% of TSX -228 products
56%
1%
21%
9%
13%Fund of Funds 166 issuers
MF partnerships 101 issuers
ETF's 17 issuers
Split Share Corps 27 issuers
Capital Trusts 8 issuers
Source: TSX Group Inc.
TSX New issues market
0
2
4
6
8
10
12
14
16
18
1999 2000 2001 2002 2003 2004
In $Billions
Structured products Corporate Income trusts
Source: TSX Group Inc.
Listed Structured ProductsEnding Dec 2004: -SP’s: $9.5B-Corp: $3.2B -IT’s: $2.9B
Assets in Billions
8.7
15.8 15.7
5.3
0.7
4.1
0
5
10
15
20
25
Dec 1999 Dec 2003 Dec 2004
Market linked GIC's Linked notes
Source: Investor Economics
Unlisted Structured ProductsGrowth yr/yr: ML GICs: -0.5%Linked Notes: 29%
Number of market linked instruments
36 57 66
216
31
145
0
50
100
150
200
250
300
Dec 1999 Dec 2003 Dec 2004
Market linked GIC's Linked notes
Source: Investor Economics
Unlisted Structured Products
Number of market linked sponsors
16 17 19
27
4
22
0
5
10
15
20
25
30
35
40
45
50
Dec 1999 Dec 2003 Dec 2004
Market linked GIC's Linked notes
Source: Investor Economics
Unlisted Structured Products
Principal Protectednotes
A debt security issued by an agent (Investment manager and backed by a guarantor (usually Schedule I or II bank)
Guarantees 100% of principal if held to maturity (a range of 6 to 10 years)
At maturity, pays original principal plus appreciation from the underlying ‘linked’ asset.
May pay a coupon (variable or fixed) with no correlation between value of this coupon and return of the underlying asset
PPN underlyingassets
Underlying assets that are ‘linked’ to notes include:
Mutual funds Group of funds An index Basket of equities Pools of income trusts Hedge funds Funds of funds Emerging markets Currencies Commodities etc
Number of market linked sponsors
0.6
4.87
8.86
16
5
17
3539
35
0
5
10
15
20
25
30
35
40
45
Dec 1999 Dec 2002 Dec 2003 Dec 2004
Assets in $B No. of sponsors No. of notes
Source: Investor Economics
Growth in PPN’sCAGR since Dec 1999: 70.3%
PPN’s: two approaches
1.Zero Coupon Bond
Strip bond with option: (example $100 note)
$70 into zero coupon or strip bond$30 into long term option on underlying assetLeverage x option ≈ $100 notional exposure to asset
Issues:A Low interest environment requires large portion of the investment to be applied to zero coupon bondMay not get leverage on call option to get $100 notional exposureCall option tied to expected volatility of asset (conservative but can be costly)Selling before maturity can be costly as the strip bond is heavily discounted to start.
PPN’s: two approaches
2.Constant proportion portfolio insurance (CPPI)
CPPI (a monitoring approach)Two components
Underlying investmentA guarantee, notionally related to a zero coupon bond that matures at 100%
Formula monitors the NAV of the underlying asset against a reference curve or ‘floor’ that increases over time.
Starting floor value = cost of zero coupon bond calculated to yield 100 at maturity. Over time, zero coupon bond cost increases.
As long as the investment NAV remains a specific distance above this floor (delta), all cash is kept in the investment.
Allows for leverage to be applied if NAV gains in value and removed if NAV falls below the delta (dynamic leverage)
CPPI
Example: 8 yr term, $100 note
At Time 0:Annual yield on 8yr zero coupon bond = 3.0625%Over 8 years this = 24.5%Cost of zero coupon = $75.50 (floor) rises over timeStarting delta (distance between zero coupon cost and 100) 100-75.50 = 24.5
To keep $100 in the investment, the NAV of the investment must not fall below 24.5% above the floor.
CPPI
CPPI
0
20
40
60
80
100
120
140
1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96
months
%
De-leveraging begins
Knock out
guaranteeAsset return
delta
CPPI:enhancements
Some enhancements to the CPPI structure:
Lock-ins to periodically crystallize gains above the delta
Payouts or coupon payments (return of capital until initial capital amount met)
Options on CPPI for offshore exposure within FIE constraints
Conversion of income to capital gains through derivatives
Risks
Credit rating of guarantorMitigated by using rated schedule I and II banks
Level of participation in underlying assetCPPI investment can be reduced by poor initial performance (de-levered). Harder to get back returns due to lower investment baselocked out early (end up sitting in a bond for a few years)
(assessment of underlying asset is very important !)
Cost of guaranteeDriven by interest rates
lower interest rates = lower yield = higher cost of guarantee
In unlisted PPN’s, the secondary market is at the mercy of guarantor (availability, gates, discount)
Structured Product:Fees
Strategy dependant on value of CPPI structure to an investment
Fees for guarantee (discounted to pay guarantor)
Fees for option
Plus trailers, expenses, management fees, front end fees and commissions to investment manager and advisor etc
More information &
Acknowledgements
TSX Group (www.tse.com)
Investor Economics (www.investoreconomics.ca)
Fund Library (www.fundlibrary.com)
Investment executive (www.investmentexecutive.com)
AIMA (www.aima.org)
Various regulators
Thank you
Contact details:Andrew DomanChief Operating OfficerAbria Alternative Investments Inc.20 Adelaide Street East, Suite 300Toronto, Ontario, CanadaM5C 2T6Tel: 1-416 367-9993Fax: 1-416 367-4555website: www.abriafunds.com