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Synthetic zeros look robust in market confusion
by Emma Dunkley on Jan 18, 2012 at 07:00
Synthetic zero products are offering attractive fixed returns of around 10% a year, at a time when investors are finding it tough to call market movements amid global economic uncertainty.
Wealth managers believe these products, which provide a fixed annual return as long as the respective index trades within predefined barriers, are an effective way to generate returns even if the market is moving sideways.
A safe hedge
Stuart Fox, investment analyst at City Asset Management, said he often uses synthetic zeros when he has no strong conviction on market direction.
‘These products trade within a range, so if we don’t know where the market is going, they build in a wide margin of safety. So for a market that is not really doing anything, you can get paid a reasonable amount,’ he said.
He added that with current equity market levels, valuations do not look ‘particularly compelling’, meaning synthetic zeros offer an opportunity to potentially receive an attractive annual pay-out for sideways market movements.
Fox said some products have a daily accrual mechanism – or option – meaning as long as the market trades within the range set by the product, a certain amount is accrued each day. There are also products that have yearly ranges, meaning the underlying market has to trade within the barriers for the whole year in order to receive the coupon.
‘However, it would be annoying to stay within range for most of the year and then see it fall out of range at the end,’ he said. ‘Whereas for a daily accrual product, you would get almost all the coupon for the same performance.’
Morgan Stanley has issued synthetic zeros with daily accrual, for example, which have a maturity of four years and pay out 9.25% a year if the FTSE 100 stays between 3,750 and 8,250. Investors can gain exposure to other markets, with HSBC offering a six-year product, for example, returning 8.8% a year if the S&P 500 stays within 782 and 1956.045.
Lisa Chaudhuri, vice president at Barclays Capital, said the firm will be launching a synthetic zero towards the end of January, to soak up money from four-year trades that are maturing.
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