The secret ingredients of an active portfolio

With one of the harshest drops witnessed in the equity market since the Great Crash of 1929, the S&P 500 has made a noteworthy recovery from a 30% loss earlier this year to a mere 10% loss. Through volatility (VIX), stop losses reached over 80% in March and portfolios were thus actively transformed with structured products being the most commonly traded product, which explains how structured products sales grew to an impressive 70% within a year, according to Structured Products intelligence (SPi).

Growth and income structured products have both benefited from increasing demand over the past six years. Income products, especially barrier phoenix deals, which currently make up roughly 43% of the U.S. structured products market, have been particularly popular with investors. Considering the volatility spike and the Federal Reserve’s decision to cut rates toward the end of 2019, there was a positive shift to participation products with figures showing an increase from 30% market share in February 2020 to 45% by the end of April 2020.

As a response to the COVID-19 pandemic, central banks internationally declared that they would print more money to support the global economy. This, as well as volatility reaching historic heights allowed investors to lower their entry levels on local equity indices and obtain higher fixed coupons.  In March, the industry saw an increase in annualized coupons in the U.S. market from 9% to 13% along with a 10% rise in participation on growth products, from 160% to 170%.  Moreover, the five-year treasury yield depreciated to 0.30%. 

Using structured products to enhance your portfolio

Today, the most active of investors understand the power of entry levels.  Whether the recovery will be V- or W-shaped, most equity markets do predict a recovery. We’ve seen investors play on the market’s increased volatility in the previous two months by obtaining low entry points on equity indices such as the S&P 500, while continuing to use structured products to enhance their return in one of two ways:

1)     Increase Income – during the past five months and accounting for inflation, real returns from fixed income deals turned negative. Meanwhile, recent increased volatility caused the added return of an autocall to increase to a 12% annualized yield, while barrier levels on the S&P 500 decreased to the 1,700 level (a 50% drop from January’s highs), lowering potential losses.  This meant that many active investors increased their allocation of autocalls and replaced some of their fixed income portfolios, allowing them to obtain a 10% annualized coupon by the end of 2020. Such investors would also benefit from capital protection if the S&P 500 were to fall any further.

2)    Leverage a recovery – with stop losses being hit in March, many investors were sitting on cash and took the opportunity to make lucrative investments. The Federal Reserve’s support and optimistic talk of a possible COVID-19 vaccine prompted these investors to begin re-entering equity markets.  The remaining high volatility meant they could leverage upside participation for a growth participation structured product up to 170%.  If markets were to recover to the 3,000 level by the end of 2020, investors who hold such participation deals will be able to earn an 18% annualized return, compared to a 10% return on the S&P 500.

Exploring different potential performance scenarios for the remainder of 2020, structured products will outperform other kinds of investment products as long as the S&P 500 remains above the 2,600 level. In addition, participation products will provide a good supplementary benefit to portfolios if there is a recovery by the end of this year.

At present, more and more investors are using structured products to enhance as well as to position their portfolios toward a potential recovery, in addition to taking precautionary steps to protect against a W-shaped recovery.  With volatility declining to normal levels because the VIX has decreased to 30% from its excessively high 80% levels in March, investors who actively trade in structured products are in a healthier position to recover from any losses and, later, receive positive returns.