June saw a reverse of earlier positive trends, with €25bn in investments redeemed across the continent in that month alone. With concern about markets heightened amongst investors, the laboratories which were once regularly spinning out new versions of old products, emulating innovations in laptops, ’phones and computer games, are now entering an extended go-slow period.
Watchers fear mass redundancies among funds staff at UBS could be repeated elsewhere and that some smaller, specialist houses could shut up shop for good. In this gloomy climate, innovation has a bad image, with confidence in both equity and bond markets currently at or below levels last seen at the time of the Lehman Brothers collapse back in 2008, says Robert Parker, senior adviser to Credit Suisse and a fund industry veteran.
Few assets have performed for investors in 2008, with the exception of the Swiss Franc, gold and a handful of other commodities. Increasingly popular exchange traded funds (ETFs) can also prove dangerous in the wrong hands. “If you have a market panic, it is always going to be more significant with high levels of liquidity,” warns Mr Parker.
This sense that latest inventions can have a negative influence is commonly held, with new-fangled ideas regarded with more than a touch of cynicism. Says Mattia Nocera, CEO of Belgrave Capital Management, which oversees €6bn for its parent Swiss Banca del Ceresio Group: “The real issue with innovation is about private bankers and asset managers asking: ‘How can we find a different way to charge a client some fees to manage their money?’”
Principal protected structured products, posing innovative structures and pay-offs, have really been used as a device to help the banks hold onto clients’ assets in times when customers are chasing liquidity, he believes.
“Many have five to seven year structures, which you just can’t get out of and you can only make money at the end of the period,” says Mr Nocera. “But whoever sold the structure is making money for themselves during those years, as they have locked clients in for a long period of time.”
Hedge funds have often been tarred by the same brush as structured products, because their liquidity has been restricted by managers, many of whom are motivated by a quest for quarterly performance fees, believes Mr Nocera.
Although hedge funds have proved innovative in the way they can smooth returns in portfolios by protecting downside risk and anticipating rising markets, investors have reacted against them by flocking to ETFs. “When the reaction came to lack of liquidity, it was through super-liquid ETFs which can be bought and sold every day,” he says.
“But stocks are also easily tradeable. The difference is that an ETF is strapped into a product with an extra fee for someone who manages it. To me, there is something intrinsically wrong with the concept. An index is passively constructed. But shouldn’t you really just buy the good stocks and avoid the bad, both of which change over time? We are essentially believers in active management.”
Innovation has been responsible for some of the failings of the financial industry, particularly in the structured products arena, believes Jervis Smith, head of clients for Global Transaction Services at Citi, with these crisis-era mistakes likely to recur in the long-term. “Human greed led manufacturers to conjur up triple A ratings from packaging lots of triple B products like CDOs,” he reflects.
“We are already seeing some of these excesses repeat themselves in structured and synthetic products.”
There is no problem in using derivatives as part of the product architecture in investment strategies, says Mr Smith, providing the derivative market is always dwarfed by the underlying market. “That is where the risk of synthetic ETFs lies. Derivatives are being bought on a market which is not big enough to hedge the positions.”
In particular, investors have become very suspicious of some of the more cutting edge structured products, built on less liquid underlying investments, says Mr Parker at Credit Suisse. “Since 2008-2009, they have began to avoid anything opaque and prone to illiquidity, as when there is sharp market movement, they cannot price it.”
Amin Rajan, CEO of Create Research and author of a 2011 report Investment Innovations: raising the bar, also believes structured products are an example of an innovative trend which has transformed the industry in a negative way.
“Structured products have the seductive appeal of asymmetric returns, protecting the downside, while delivering the upside,” says Mr Rajan.
