Caroline Shaw, investment manager at Courtiers, on why handling volatility is such a priority before making product choices
Have you made any gains from your structured product holdings?
We’ve had one of our structured notes auto-call and deliver a lovely return.
It’s a Morgan Stanley note that delivered an annual return of 11.35%, based on the FTSE 100, with a strike level of 5,895. We bought this two years ago.
There was no auto-call in the first year, so the second year was the first opportunity for it to auto-call. We made more than 22% on that, which is a very attractive return given the FTSE 100 has been mostly flat over this time.
However, if the FTSE 100 fell down during this period, you got killed on the mark to market. So in 2011 in August, when the market tanked about 10%, the note went down too. So we took a big hit on the mark to market in August.
As a result, I haven’t rolled this into a new product, because our volatility levels would look really high. Our clients want smoother returns, and protection.
Furthermore, as volatility is so low, these notes are now not priced as competitively as they were a couple of years ago.
So, we are looking to pick up more products in the secondary market if and when the FTSE falls again, rather than opting for primary issuance.
Why is volatility such an issue?
It can really work against us, for our clients and versus our peers, when they see their valuation drop daily. It’s not attractive in a Cautious Risk fund, where people want lower volatility.
We’ve worked to ensure our Cautious Risk fund has a bit of protection in there for clients, so when the markets go down, the protection kicks in and lowers the volatility.
If a structured product is in there and the mark to market pricing takes a hit, it impacts figures and the client sees this.
It doesn’t matter if the long-term outcome is good; they are concerned if the short-term outcome is poor.
It has done brilliantly over two years, though, so this is really a sentiment issue.
What are some of the exchange traded funds (ETFs) you hold?
We have a long position in Latin American equities in our funds, via a db X-trackers ETF. In our model portfolios, we have fixed income ETFs, the FTSE All Share, the S&P 500 and the iShares MSCI World.
While we hold the db X-trackers Latin America, we are looking at this, because of the lack of love we have for Brazil. We have an issue with the state-owned companies it tracks – Petrobras is my problem.
Lots of companies will do well and the Brazil story is attractive; but we could end up with a shift to a more active type of product, due to the large exposure in the index to state-owned Petrobras.
What’s your view on the outlook for fixed-income market and how are you implementing this exposure?
We only have a small amount of exposure to fixed-income ETFs alongside our active holdings. We have a short duration iShares Markit iBoxx Sterling Corporate Bond 1-5 year ETF and an iShares Markit iBoxx Euro High Yield Bond product. We’ve been happy with an asset allocation play.
We’re looking to shift our portfolio to shorter duration, because of concerns about interest rate risk, so this will hedge it out a little more. In the funds, we can also go short gilt futures.
Have you made any changes to your ETF due diligence?
We’ll be factoring the execution of trades into our due diligence now – we’re trying to work on more efficient execution.
Some brokers don’t take commission on trades, but they take a spread. But if a broker takes a 10-20 basis points commission, this is big if you’re only trying to track an index. It means you’ve really reduced your ability to track that index.
Tracking error can also be a real issue. However, if you look at the data the groups produce, it’s all over the place. There needs to be more alignment with the data produced in the market.