A bear steepener for interest rate risk, a capital-protected notes for those who don’t want to risk anything or a bonus certificate for prudent risk-taking.
The post-covid period of high inflation has been associated with a concomitant decline in both stock and bond prices. This resulted in a positive correlation between these two asset classes. So that bonds no longer necessarily constitute the preferred diversification asset compared to stocks. A situation which favors alternative strategies, many of which are based on the use of derivatives and structured products to which these derivatives are attached. The objective may also consist of hedging the portfolio or making it more efficient. We have identified three product categories corresponding to diverse views of the market.
Obviously, one of the main risks is linked to the term structure of American interest rates. After a long period of inversion between the 2-year and 10-year rates, the 2s10s spread, which was negative at almost -0.50%, returned to positive territory at 0.30% (as of Tuesday January 22, 2025 ). This is explained by the rise in long-term rates, while short-term rates follow an opposite trajectory induced by current monetary policy.
“This is not only a momentum idea, but also a strategy that assumes a normalization of the Treasury market.”
However, an underlying strategy making it possible to exploit the increase in the spread between two maturities is called “Steepener”. In the case of a “Bull Steepener”, it is the short rates which fall more widely and more quickly than the long rates. In the present case, however, the markets are facing a “Bear Steepener”, that is to say a more rapid rise in long-term rates (sale of bonds), a situation which was also observed during the correction of the market between July and the end of October 2023. Implementing such a strategy would consist of taking a long position on short-term bonds and a short position on long-term ones.
“It is not only an idea of momentum, but also a strategy which supposes a normalization of the Treasury market”, explain in a note the experts of the automated platform for issuing investment products, Halo Investing. “It is possible that Treasury yields will continue to fall, while the soft landing scenario reveals itself in the form of a higher long-term bond rate,” they add.
Outside of the interest rate market, investors with greater risk aversion can opt for the simplicity of a capital protection product. However, the expected continuation of the fall in short-term rates, induced by the Fed’s monetary easing policy, could make it difficult to issue capital-protected notes (CPNs) on attractive terms.
-Short-term rates in fact determine the difference between the issue price and the nominal value of the zero-coupon bond which constitutes a CPN. Difference that provides financing for the purchase of the option intended to remunerate the investor. With rates currently low, the present value of the bond is too expensive for the issuer to leave sufficient resources for the purchase of options used to finance the participation in the underlying.
“The bonus is one of the least issued and traded participation products on SIX Structured Products.”
Finally, a fairly large number of investors are beginning to accept the idea that the economic fallout from President Donald Trump’s trade policies would not necessarily be negative. At the same time, certain objective realities are of concern. Like the congestion of the American market. And the fact that the top ten capitalizations of the S&P 500 alone account for almost 40% of the total weight of the index. Not to mention the fact that only 26 stocks, most of them from the technology sector, represent about half the weight of the aforementioned index, according to data from the S&P Dow Jones Indices recently relayed by the Financial Times.
Hence the interest of the bonus certificate, which combines participation in the evolution of the underlying asset and conditional protection of the initial investment. It is one of the least issued and traded participation products on SIX Structured Products. Only one certificate was issued in January, namely the Vontobel note on Novartis shares, maturing on January 27, 2027. Issued in euros, with Quanto protection against exchange risk, the product displays a fairly conservative bonus level. , set at 91.36 francs, compared to a spot price of 90 francs (Wednesday January 22), as well as a barrier set at 72.14 francs (a difference around 20% compared to the spot price).
One of the main advantages of the bonus certificate is that it guarantees the reimbursement of the product on maturity, the minimum amount of which corresponds to the so-called “bonus” level. But this, as long as the underlying, in this case Novartis, does not touch or does not fall below its security threshold or “barrier”, i.e. 72.14 francs, during the duration of the certificate.
The icing on the cake is that the investor continues to participate in the rise in Novartis shares, even if it exceeds the bonus level of 91.36 francs. However, if the barrier is hit, the protection mechanism is canceled and the investor finds himself in exactly the same situation as if he directly held the underlying stock. It will thus participate, both downwards and upwards, in the evolution of the underlying security until the product matures.
