Demanding and careful character of Russian investors
Over the recent decade, the Russian exchange market as well as the attitude of a Russian investor, has transformed significantly. Structured products have developed rapidly since entering the market for the first time in 2004 and the transformation has intensified after sub-prime mortgage crisis. Post crisis Russian investors have become more cautious but not less demanding.
Federal Reserve and the ECB have kept base interest rates close to zero. The Central Bank of Russia has also an accommodative policy: The prime rate is 8.25% p.a and the 6 month repo rate is 7.5% p.a in RUB. These levels are accommodative as RUB inflation is close to 6% p.a.
The sovereign and Russian bank credit spread are wider than those in developed countries with deposit rates that can exceed 10% p.a in RUB and 3.7% p.a in USD before taxes. Russian corporate Eurobonds with a good credit rating can yield up to 8% p.a in USD before taxes (leveraged Eurobond position can bring more than 12% p.a).
So, while the developed world lives in negative real interest rate environment, Russian investors benefit from an attractive investment yield in RUB and USD, taking only credit risk that they feel comfortable and familiar with.
Taking the above into consideration, the structured product market in Russia is quite challenging particularly for USD denominated products since structured products should beat deposit rates and compete with leveraged Eurobond positions maintaining moderate level of risk and high level of return.
Pre-crisis volatility of Russian ADRs provided an opportunity to create attractive autocallable structures which paid around 30% p.a in USD. Typically, Russian high net worth clients invested in such products, taking market risk, very willingly. Post-crisis, the situation changed significantly. Now investors still want to see high return but with much lower market risk.
Hence for autocallable notes, Alfa Capital now offers risk reducing strategies, such as «defensive autocallable» notes developed by Commerzbank. The Additional features of such notes reduce the market risk at maturity, as investors will not loose money if at least one stock is above its initial level, even if the worst performing stock is below knock-in barrier. This strategy is effective when overall market conditions are favorable but one company suffered negatively due to specific corporate events. As defensive features appear more regularly at the top of our clients’ requirements we also propose snowball features, with a low or decreasing autocall trigger. When designing such structures we generally select a combination of high and low volatility stocks of promising American and European stocks which enable us to lower market risk while capturing attractive level of returns.
For the most cautious investors we develop 100% capital protected notes. The main barrier here is the low USD funding level which often do not allow good returns. Occasionally, we increase funding by embedding additional credit risk. However, currently credit spreads for the most liquid Russian names are too tight to design attractive products. A solution may be found in employing credit risk without a liquid CDS market and using their bond-backed notes instead. Unfortunately most suitable Eurobonds are subordinated which many banks are unwilling to embed. In this case it is worth considering Special Purpose Vehicles (SPVs)1, such as Agate, proposed by Commerzbank.
Another challenge for capital protected products is the choice of the underlying investment exposure. Some assets are too volatile and options on them are too expensive. For instance, a common request, among Russian investors, is a capital protected product in USD linked to the gold price upside. However, gold forward curve and volatility level make it difficult to create an attractive vanilla product. Under such circumstances, several knock-out triggers with different participation levels for each trigger might be implemented to create a product with acceptable growth potential. These pay-off is commonly called «Chinese Fan»
In conclusion, the typical Russian investor is now more risk averse while still expecting high returns due to the higher interest rates environment in Russia. This often leads to a challenging situation to find a suitable investment solution with traditional asset classes. The structured products field is constantly evolving, both in terms of non-capital and capital guaranteed products. These offer many opportunities to meet client’s increasingly demanding expectations. Understanding our clients’ needs, combined with our knowledge in financial engineering and the wide variety of pay-offs allow us the opportunity to consistently make the right proposal to our defensive and careful investors.
1Special purpose vehicle (SPV) — a subsidiary corporation designed to serve as a counterparty for credit sensitive derivative instruments.