Views of our experts

The hour of (financial) reckoning

A little journey through time. Not the kind made in a DeLorean; the faintest of memories is all we need. One year ago, growth companies were sailing along on the wave of appetite for risk. Although we could each see the clouds on the horizon, nothing could quell the enthusiasm of investors emerging from the Covid crisis.

With volatility at low levels (approximately 17% in August 2021), investors searching for high-yield coupons shifted their focus to growth stocks with higher volatility that few imagined would experience such a severe correction.

Then came the year 2022... and the clouds glimpsed in 2021 were suddenly hovering over our incredulous heads: inflation was rising, the US central bank was on shaky ground, and the end of highly accommodating monetary policies was fast approaching. In February, war broke out in Europe, and inflation was fuelled by the conflict between two of the world’s biggest producers of raw materials. This mixture of uncertainty, which is harmful to the markets, and rising prices was a devastating cocktail for the Nasdaq, the American index for technological securities, which fell by up to 30% in June. Certain shares included in the index plummeted by up to 80% from their highest value, with the drop affecting even leading securities such as PayPal and Meta Platforms (formerly Facebook).

And today, we find ourselves in this situation that was so dreaded by those investing in structured products: once maturity is reached, they must accept a stock whose value has fallen significantly. However, they had initially chosen stocks that were seen as behemoths immune to such a dive. Who could have imagined that Meta Platforms, once the strongest stock in the world, could lose 60% in just a few months? The hour of reckoning is approaching, and it’s time to act: what should be done with these products?

There are three possible ways to manage these situations. First, restructuring by selling off the problematic product and purchasing a new one in an aim to minimise or even offset the loss. The greater the product’s price drop is, the less feasible this restructuring becomes. Second, simply await the product’s maturity in hopes of a recovery, and keep the security received since, after all, the investor was confident in the security when the product was launched. Third, sell the product and take the loss.

There are several lessons to draw from these events. It’s essential to carefully choose underlying assets, as the risk of receiving them is built into these products. Next, it’s important to be cautious about trendy themes that are sometimes comprised of overvalued securities that are the most susceptible to intense correction in the event of turbulence (they also have the greatest volatility and therefore offer the best coupons). Finally, we must never forget the risk/return profile of these products: they offer a capped return... but the risk of loss is unlimited. They should never be confused with bonds: the higher their return, the greater their risk.

Author

Abdelkarim Hamidouche

Structured Products Specialist

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AN INTRODUCTION TO STRUCTURED PRODUCTS

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