Context: Opportunity in Uncertainty
The structure of the financial industry has changed substantially over recent years. Whilst the overall size of markets has reduced, there are areas including Delta One, which see growth – either in absolute – or relative scale. There are also significant new opportunities.
The post GFC world has seen a flight to simplicity in financial products. End users, many of whom have suffered significantly, require easily understandable, predictable and transparent, low cost products. This has triggered an increased awareness of and appetite for Delta One.
Evidence includes the proliferation of established and new Exchange Traded Funds (ETF’s), equity swaps, futures, forwards and other similar derivatives. Risk management and regulation too are more visible, and important. Focus on counterparty risk and a move to using exchanges or central counterparties is changing the way markets operate.
The Evolving Market: Beta is the new Alpha
More than ever before, getting beta right is a major goal when creating a robust well performing investment portfolio. There is a wide and growing choice in the range of betas available for investment, and in the instruments that can be used to deliver it. Making the right choice is not straightforward. It comes down to a combination of asset allocation, risk management and implementation.
No longer is beta regarded as the core to a portfolio, with alpha adding or boosting performance. Beta is now inextricably tied to absolute returns. Getting beta right adds alpha to the investment process. No longer is alpha the domain of hedge funds, stock pickers and active managers, and beta for passive managers and index trackers. The boundary is not distinct any more.
Delta One: Delivering Beta
Delta-One can be loosely defined as relating to products or strategies which involve linear outcomes. In other words, they deliver beta, where beta is defined as exposure to a single asset, baskets of assets or an index. Beta is not restricted to any particular geography, sector or asset class.
Increasingly, end users want to choose betas, and then choose the products they use to deliver that beta. Products with exotic or difficult to understand payoffs have decreased in popularity. This all plays to the increased importance of Delta One.
Synthetic or Physical
Beta delivery can broadly be divided into two forms: physical and synthetic. The relative merits of these are the subject of much discussion, even controversy. There are definite advantages to each, and also different risks. Investment banks tend to be the main source of synthetic beta (exposure to markets or sectors).
Many asset managers recognise that while banks have expertise and synergies in synthetic beta provision, they also introduce new risks to a portfolio or a strategy. Provided that these risks are understood, and managed appropriately, synthetic beta can be a viable alternative to physical replication, as it can free the asset manager to focus on their core expertise, whatever this may be.
In contrast, physical replication requires an asset manager to replicate a given benchmark. Tracking must be managed within the guidelines of their mandate, and any error (positive or negative) will pass through to the end product. Physical and synthetic replication are not mutually exclusive. Together, they can be part of an optimum strategy.
The product providers’ challenge is how to deliver the best outcome when all possibilities are taken into account. Whether the end result is physical, synthetic or both is part of this challenge.
Australia has a thriving and sophisticated investment management industry. Compulsory requirements to provide for superannuation generate regular inflows of funds. This in turn leads to a lot of choice and competition for their deployment.
The growth of self managed superannuation (and SMSFs) allows individuals to take control of their own retirement savings. Whilst industry funds and pooled investment vehicles still take up the majority of inflows and existing funds, the mix is changing.
New products are becoming available for both personal and institutional superannuation funds. For example, the growth of ETFs means that both retail and institutional investors can access a wide range of exposures by trading simple listed securities. Institutional investors have further access to the synthetic markets as well as the choice to manage exposures physically.
CFDs (contract for differences) are available as a retail product, but their use has to date been mostly for speculation. The new mySuper requirement means that fund managers are looking for an efficient and effective default product to compliment their choice offerings. Delta One, will most certainly be part of any offering.
Portable Beta works with parties deciding to enter the delta one arena, and with established participants. We help with evaluating a strategy, identifying new opportunities, designing new products or benchmarks, or providing background and education.
In a continuously-evolving market, the success or failure of a strategy hinges upon the simultaneous consideration of Trading, Sales, Operations, Regulation, Structuring, Tax and more. Portable Beta adds value because it has a comprehensive view and understanding of the Delta-One space; it assesses product provision (and investor requirements) from different angles.
Working together with clients to develop a strategy – whether structuring a new product, solving a platform problem or creating a business model – Portable Beta can bring expertise and independence to the development process. This comes from understanding the landscape, the product, and knowing where to draw on the expertise of others.
Portable Beta can provide advice about all facets of delta one and related products. Ranging from education, how they work, theory and practice, structuring, pricing, trading, hedging and managing risk. A sample of areas covered includes:
- Equity index and single stock swaps
- Securitised products (notes, certificates, warrants)
- Exchange traded funds (physical and synthetic)
- Collateral management
- Inventory management
- Stock loan and repo.
- Links to options and other derivatives
From trading to asset management to product design and provision, Portable Beta works with clients to help determine how their business should be structured, what resources, infrastructure and support are required.
Assessing what can be done in house, and what should be outsourced is vital in growing a business. The choice of systems, infrastructure, strategic alliances and suppliers is equally important. Progress is achieved by working closely with clients, understanding their needs, providing links to other professionals and service providers in the marketplace and working with internal stakeholders.
This type of work is highly bespoke, and varies depending on the client. Generally a detailed assessment is part of the engagement process, as is continuous review and tuning of the outcomes.
Guidance in executing a plan, locating resources and technology is a vital part of any development. Portable Beta will work with internal and external consultants and management during the implementation phase.