A first-of-a-kind capital-protected note which can invest in exotic credit instruments has hit the market. SG Corporate & Investment Banking is marketing the note, which also features a bespoke value-at-risk model to protect capital. Several other firms, including ABN AMRO and Calyon, are also working on capital-protecting exotic credit funds, but SG is the furthest ahead, looking to close its deal later this month.
The market is abuzz about the deal because it is seen as stretching the boundaries of current constant proportion portfolio insurance structures. These so far have referenced only portfolios of single-name credit-default swaps or indices.
The coupon on the notes is linked to the performance of actively managed credit strategies which include single-name default swaps, synthetic collateralized debt obligations and credit index tranches, handled by a European asset manager, according to Edouard Huntziger, director in structured derivatives at SG in Hong Kong. AXA Investment Managers has reportedly been tipped for the manager role, but Huntziger declined to confirm that.
The strategy will employ value-at-risk modeling daily, in which extreme losses will be measured across net positions. If the VAR on a particular day is closely approaching a set breach level in terms of potential losses in extreme movements, the asset manager will readjust or hedge outstanding positions. Huntziger said SG spent six months working with the manager, providing in-house proprietary models and technology for the deal.
"While CDOs have developed steadily over the last five years, we've seen a tremendous amount of change in CPPI technology in just the last year," Huntziger noted. CPPI products are moving from simple credit-index-linked deals to multiple credit strategies actively managed by asset managers, he added. "The job of the asset manager is to switch opportunistically between the three components of credit risk: correlation risk, credit spread widening and default risk," he said, explaining the strategies will incorporate long/short plays and will also be leveraged. "Credit spreads are tight and there is a need for credit enhancement," noted Huntziger, explaining the flexibility given to the manager should allow for good returns in any environment.
The product is now being shown in the U.S., Europe and Asia, to institutional investors and private banking clients, Maturity is typically 10 years but the structure is flexible so maturities. currency, coupons, and percentage of principle protection can be adapted.
