Outlook 2024: Market conditions, adaptability suggest sales of structured notes to rise

By Emma Trincal

New York, Dec. 29 – The structured products market held on well in 2023 given geopolitical tensions, interest rates volatility, recession fears and a regional bank crisis.

Structured notes issuance will probably outpace the $95 billion of 2022, according to the latest data and extrapolations compiled by Prospect News at press time as of Dec. 8.

The year 2023 was “a good year,” said Shilpa Akella, head of equity derivatives structuring, Americas at Barclays Bank.

“We anticipate growth for the upcoming year. We see issuance volume increase in the single-digits, or even higher single-digits.”

Calling

A distributor based his forecast on call activity and market conditions.

“The minimum issuance now appears to be around $100 billion each year and not $50-60 billion as it was the case five years ago,” said Brady Beals, director, sales and product origination at Luma Financial Technologies.

“I see growth for the year ahead although it’s always contingent upon what happens in the market,” he said.

“If the market is up and notes get called, I expect an increase in issuance volume of 20% from this year.”

His call assumed that call activity in a bull market can represent approximately 40% of annual issuance.

“If call activity picks up by 50%, which is reasonable if markets continue to rise, I’d expect a 20% rise in total issuance.”

“On the other hand, in a down market with no call activity, the tally for new issues may be flat or slightly down,” he said.

However, the total outstanding, or “live” notes will continue to rise at about 10% per year, he said.

“I don’t see that changing. It’s just a matter of whether new notes need to be issued due to call activity or not,” he said.

The volatility factor

Last year saw a shift from the previous one with a downtrend in the VIX along with rising interest rates. Meanwhile a short-lived banking crisis brought credit risk concerns to the forefront.

Volatility jumped shortly during the regional banking crisis in March pushing the VIX index to 31, well below the 85-level recorded at the onset of the Covid-19 pandemic. The VIX declined throughout the year to 11.81 in December, a new bottom not seen since 2019.

A subdued volatility does not help sales of structured notes, said Mark Dueholm, chief fixed-income trader at Landolt Securities.

“When volatility is high, pricing becomes much more attractive. Your coupon is higher, your entry point is lower. That’s the best time to buy,” he said.

For Beals, however, those tactical trades have limited effect on issuance volume.

“Yes, people try to lock in better terms during a correction and some sophisticated advisers always have money ready to go if volatility spikes. But only a limited number of players do that. It’s pretty much limited to the RIA space,” he said.

Rates down

One of the biggest unknowns in the past year has been the direction of interest rates. Market participants hoped that more clarity would prevail in 2024. As it turned out, the last Federal Open Market Committee meeting on Dec. 13-14 shed some light. Fed chair Jerome Powell’s speech and Fed officials’ new projections signaled three rate cuts in 2024.

But a drop in interest rates does not have the same implications if it’s driven by monetary policy or by a deteriorating economy.

“If inflation begins to cool, driving the Fed to cut rates, we’ll have a recovery trade with a strong demand for leveraged notes and a pickup in calls,” said Beals, who spoke ahead of the FOMC meeting.

A less rosy picture could be signs of a hard landing forcing the Fed to ease.

Such scenario would put pressure on equity markets, bringing autocalls to a halt, noted Dueholm.

Autocall reinvestment proceeds in the past year have already felt the pinch of the bear market of 2022, he said.

“I don’t think a whole lot has gotten called in 2023 in spite of a good performance in the stock market,” he said.

The S&P 500 index throughout the year has not returned to its all-time high of January 2022, he added.

At press time, the S&P 500 index had just hit a one-year high but was still off its record high.

“We need a bigger bull market, and we may not have it in 2024,” he said.

Some of the effect of a slowdown in call activity may be partially offset by issuers calling notes, which would reintroduce proceeds into the market.

“Rates will go down in the upcoming year and we could see a lot of issuer calls as a result,” a trader said.

“Notes that haven’t’ gone anywhere for the past 18 months will be called regardless of their performance. This will increase volume because most of the proceeds will be reinvested into new notes.”

Another benefit of lower interest rates would be to make yields on cash and Treasuries less competitive.

Higher rates

The opposite hypothesis – a rise in interest rates – also had several ramifications.

Interest rate volatility has led a number of investors to shift their money from bond funds to structured notes, preferring the equity exposure to interest rate risk, Beals said.

In addition, higher interest rates have also improved the terms of many structures, especially principal-protected notes, which had nearly vanished during the zero-interest rate cycle.

Adaptability

Even though sales of structured notes are market-dependent, other factors have supported the growth of the industry over the past few years. The trend is expected to continue.

Structures are flexible and can be engineered, improved or recreated to match changing market environments. Such adaptability can drive sales, said Dueholm.

“I see one big reason to expect a pickup in issuance,” he said.

“You can always sell a ton of products because each market participant – adviser, salesperson, client – has a different opinion and for each of those opinions there is one product.”

Gaining traction

Education, automation and competitive bids between issuers have facilitated the customization of products. With more transparency and more effective operations, advisers have progressively adopted the product.

A study by a research firm specializing in the financial industry suggested there is still more room for growth.

Twenty two percent of financial advisers are using structured notes in their practice, while another 8% reported that they planned to start using notes over the next year, putting the asset class in the same range as hedge funds and private debt use, according to a report published by Cerulli Associates in August.

An additional 26% of them have used structured notes although not currently.

This leaves the space wide open for 43% of advisers who have never used or do not intend to immediately use structured notes.

“I think we’ll have a good year in 2024,” said Ken Nuttall, chief investment officer at BlackDiamond Wealth Management.

© 2015 Prospect News.
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