A novel series of capital-protected equity volatility notes designed for an insurance company has come to light after it was rated by Moody's Investors Service. The notes, issued by a Dresdner Kleinwort Wasserstein special-purpose vehicle, reference an equity volatility strategy that has typically been the domain of hedge funds, rather than institutional or high-net-worth clients.
The deal was rated for this particular client, explained Roberto Silvotti, managing director and head of global derivatives new product development at Dresdner in London. He added the firm has also structured one or two similar bespoke products for private placements since the end of last year. In the deal, the coupon of the three-year notes references a Euro STOXX 50 volatility strategy, with 100% capital protection structured through synthetic constant propotion portfolio insurance. The coupon is generated by selling implied volatility--which typically trades at a premium to realized--through rolling one-month variance swaps. Silvotti declined to reveal further details about the structure of the notes, the size of the deal, or whether Dresdner is hedging the CPPI gap risk.
Selling implied equity vol through variance swaps is a strategy typically pitched by hedge-fund sales desks to clients, but rival structurers said it is a clever idea to pitch this in a capital-protected, rated format to less-sophisticated investors. "The name of the game right now is to get these trading strategies and make them available to other types of customers," said one structurer, who said his firm is also looking into this. But officials at other firms said the complexity of the strategy--the idea of volatility as an asset class--may mean it has limited appeal. UBS and Merrill Lynch launched one-off equity volatility products aimed at institutional clients two years ago (DW, 3/7/04), but the structures have never become mainstream and it could not be determined if they were repeated.
The Dresdner deal is also unusual because it is an equity transaction with a rating. Neelam Desai, senior analyst at Moody's who worked on the deal, noted the SPV structure means the rating is a reflection of Dresdner's credit quality, rather than the underlying. Silvotti credited his firm's multi-asset class structuring unit, created last summer, with helping Dresdner to come up with and structure original products.
