QIS: A structured investment approach for uncertain times

The start of 2022 has upended expectations of lower-for-longer interest rates and sent shockwaves through global equity markets. As central banks begin to tighten policy in a bid to head off rising inflation, will traditional allocation strategies continue to perform for investors?

“For decades, government bonds have performed a dual role in multi-asset portfolios,” says Etienne Grisey, Head of Equity Derivatives Structuring, Asia Pacific at BNP Paribas. “They provide a reliable return and prevent downside losses when equities falter.” 

But the Covid-19 response has driven bond yields so low that returns are no longer attractive – and the only way for yields is up. Having languished below 1% in early 2021, the US 10-year Treasury yield has already retraced to 2% by mid-February.

At the same time, the liquidity injected by economic stimulus schemes has boosted equity valuations. But many investors feel stocks may be approaching an inflection point as central banks step up the fight against inflation. 

Investors’ conundrum

If the outlook for both equities and bonds is equally uncertain, this poses a conundrum for conventional investment strategies.

Historically investors have applied balanced portfolio rules in their liquid investments, such as the 60/40 allocation rule. The aim for their fixed income investment is to achieve two elements: firstly to generate positive carry, and secondly act as a downside hedge in times of equity sell-off.

In the current market environment these investors are looking for alternative products to help navigate this challenging duality. Where do they invest?

“When bonds fail to offer adequate diversification, the traditional options include commodities, cash, or alternative investments – but these all pose problems of their own,” commented Grisey. “A high cash allocation will dent real returns. Commodities can offer great diversification during inflation periods, but lie outside many investors’ mandates.”

Similarly, alternative investments can be difficult to access and illiquid – a particular bugbear for investors.

Searching for solutions

In these challenging circumstances, QIS present an attractive alternative for some investors. At their core, QIS aim to harvest returns from market patterns that have been well documented by academic research.

Through structured products, warrants, certificates, structured deposits or over-the-counter (OTC) derivatives, investors can gain exposure to different themes and various asset classes with a single investment. 

“QIS provide an efficient way for investors to access a diversified portfolio of assets,” said Grisey. “For investors who lack the capacity to assemble a range of thematically linked shares and bonds, buying a derivative based on a basket of these assets provides the same result.”

Diversifying the investor base

Grisey observed that the types of investors accessing QIS are becoming more diverse.

“A quantitative, data-driven approach that offers stability and counter-cyclical returns in volatile markets clearly appeals to both institutional and high-net-worth investors,” he said.

“Hedge funds, which haven’t previously been interested in structured products, are also increasingly catching on thanks to the flexibility and the daily liquidity they can offer.”

In Asia, in particular, investors seeking an escape from the negative returns generated by excessive cash in their portfolios are turning to structured products to enhance their yield.

“This is especially true in Japan, where we have seen the biggest growth in inflows in recent years,” said Grisey. “Investors also gain confidence from products that are stable and resilient during times of volatility.”

Hamzah Kahloon, Head of Structuring and Solutions, Asia Pacific at BNP Paribas, added: “Careful structuring can create a package with known upside and risk parameters, which takes some of the guesswork out of alternative investing. The growing interest in QIS shows that investors are expecting to work hard to generate above-market returns in 2022. Accessing yield enhancement opportunities combined with a proportionate degree of risk protection is an attractive proposition at this point in the cycle.”