Volume up for year at $37.38 billion; push in currencies seen as investors try to diversify

By Emma Trincal

New York, Nov. 9 - Volume in the first week of the month dropped from the prior week, as expected in this part of the monthly calendar.

On a month-to-date basis, the picture was mixed, according to data compiled by Prospect News, which does not include exchange-traded notes.

But the year remains ahead of 2010.

Volume

Sales of U.S. structured notes in the week that began Oct. 31 and ended Nov. 4 amounted to $406 million, a 68% decline from the week before when end-of-the-month volume jumped to $1.25 billion.

Agents sold $322 million in 47 deals from Nov. 1 to Nov. 5, nearly twice as much as the $165 million notional amount priced from Oct. 1 to Oct. 5 in 52 deals.

But when comparing last week, which was the first week of November, to the first week of October, or Oct. 3 through Oct. 7, the result was less encouraging. Volume fell by 34.5% to $322 million from $492 million.

The year-to-date figures bring a note of optimism. Volume rose by 12.5% to $37.38 billion from Jan. 1 through Nov. 5 from $33.22 billion during the same period of 2010. The number of offerings grew as well, to 5,891 from 5,402.

Investors last week bid on currency-linked notes, an asset class traditionally weak as a percentage of the total volume.

Currency push

Currencies rose by 27.5% last week compared to the prior week with $51 million priced in four deals, or nearly 13% of the total, compared to $40 million last week, or 3% of the volume.

Part of the relative strength of this asset class is due to a decline of equity, which fell 70% to $281 million from $921 million the week before.

But sources said that the gain in market share recorded by currencies would suggest a renewed interest on the part of investors in this asset class.

Currencies indeed account for only 4% of the sales volume for the year.

The top currency deal last week was the second largest transaction. JPMorgan Chase & Co. priced $41.2 million of 0% single observation capped market plus notes due Nov. 13, 2012 linked to the performance of the Mexican peso relative to the dollar.

If at maturity, the currency loses more than 20%, investors are fully exposed to losses; otherwise, they will receive par plus the greater of the currency return and a contingent minimum of 11.15%.

Cheap FX options

A New York sellsider said that pricing in the options market could be the driving force behind the issuance of currency-linked products.

"Buyers of those currency notes are bullish on emerging markets and are attracted to their high-yield currencies. But in the forward market, they're taking the opposite view. They're bearish on emerging market currencies and see a year from now those yield getting lower and those currencies, like the Brazilian real, getting weaker," this sellsider said.

"So you can sell the dollar at a higher rate in the forward market and it really cheapens the cost of the options for those notes."

For instance, the purchase of a call option on those currencies may be cheaper. Similarly, the sale of a put option used for the barrier that protects some of the downside on those notes may pay an attractive premium, he said.

Most recent currencies notes issued in the market are bullish on emerging market currencies or high-yielding currencies and bearish on the dollar.

Many investors will play the carry trade going long the currency with a high yield and financing that purchase by selling the currency with a low yield.

Good option pricing is also due to the opposing views between retail investors who are bullish on emerging markets and the sophisticated investors who are not, said Sebastien Galy, senior currency strategist at Société Générale.

Fast money, slow money

"Sophisticated investors are scared out of their wits by the tail risk, by a crash or the break up of the euro zone or a collapse in Asia," Galy said.

"While emerging market currencies offer high yield, the smart money, the fast money is predicting that those currencies will collapse. Nobody wants that risk on their books. So the cost of protection is very high.

"So if you're putting together a bullish note on those currencies, it gives you very attractive pricing. The options are cheap."

Reflecting on the differences in market bets between retail investors and more sophisticated investors, Galy said, "I'm always aghast at the opposite views."

But the difference may reflect different investment horizons, he noted.

"Being bullish on the Mexican peso or Brazilian real a year from now may not be a bad trade. But the fast money is quicker, has tighter risk management requirements and is shorting those currencies.

"I guess it all depends on your term, your holding period.

"If you have stronger nerves, a long-term view and the right view, you're going to make money.

"The currencies structures allow you to hold on to that position, and if you hold it one year, you have a chance to be right.

"The fast money will take the opposite view.

"Putting together a structured note may be seen as some sort of arbitrage between buy-and-hold investors and fast movers."

For the sellsider, currencies have always been of interest to retail investors, but the products are mostly delivered in certificates of deposit wrappers, not notes.

Equity exit

Other recent market developments also help explain the appeal of currency-linked notes.

"People are doing pure currency plays to diversify. It's decorrelated from equities," the sellsider said.

"The equity market for emerging markets has underperformed the U.S. this year. Look at Brazil."

Brazil's Bovespa index is down 17% year to date while the S&P 500 is flat.

"If you're bullish on emerging markets, one way to do that is via currencies," he said.

He noted that after the 2008 credit crisis and today's sovereign debt turmoil, investors are looking for alternatives to equities.

"Currencies is becoming a new asset class," he said.

Another factor is a renewed interest in shorting the dollar.

"Investors anticipate a new round of stimulus from the Fed; they think QE3 is coming. If that happens, the implications for the dollar will be negative," he said.

"Combined pricing conditions with these market factors and you see why people are interested in pure currency plays."

Douglas Borthwick, head of trading at forex execution firm Faros Trading, agreed that investors are ready to give a closer look to currencies-based products.

"The other asset classes, the sovereign bonds are losing their luster," he said.

"The yields in the U.S. are not meaningful.

"People are questioning the equity markets showing extreme levels of volatility.

"There are two asset classes right now that investors are looking at: gold and currency."

One deal, albeit an equity one, evidenced this lasting interest in gold last week. It was the No. 3 offering in size.

Barclays Bank plc priced $34.34 million of 0% Accelerated Return Notes due Jan. 11, 2013 linked to the NYSE Arca Gold Miners index with Bank of America Merrill Lynch as the agent.

The payout at maturity will be par of $10 plus triple any gain in the index, capped at 33% with full exposure to downside losses.

Borthwick, who services sophisticated investors such as central banks and hedge funds, said that U.S. retail investors are not as familiar with currencies as an asset class as they are in Asia and Europe.

"In Japan, 34% of the currency market is made of individual investors," he said.

"It hasn't been the case in the U.S., and it's primarily due to the way it's being marketed. Currency is not seen as an asset class.

"But individual investors are increasingly interested in putting these currency assets in their portfolio.

"Structured products linked to currencies make it attractive for them as they offer some kind of guarantee or protection."

Leverage

Equity indexes represented 62% of last week's volume, and stocks shrunk to a low level of 7% of the total.

The S&P 500 was down in the early part of the week on the news of a referendum in Greece but rallied thereafter with the benchmark finishing flat. The CBOE Volatility index, or VIX, also finished flat after a spike on Tuesday.

Leverage continued to dominate as the top structure last week. It amounted to more than half of the volume.

As a percentage of the total, leveraged notes with no protection (25.74%) were roughly evenly split with enhanced structures offering partial downside protection (27.04%).

The top leveraged deal was the No. 1 offering brought to market by Barclays. The firm issued $63.24 million of 0% Accelerated Return Notes due Jan. 11, 2013 linked to the S&P 500 index.

The payout at maturity will be par of $10.00 plus triple any gain in the index, capped at 21.18% with full exposure to losses.

Bank of America Merrill Lynch was the top agent last week with $175 million, or 43% of the total sold, in 10 deals.

It was followed by Wells Fargo with $71 million, or 17.5% of the total, in six deals.

Wells Fargo ranked high as it brought to market the fourth largest offering.

Wells Fargo & Co. priced $31.15 million of 0% growth securities with upside participation and contingent downside protection due May 6, 2016 linked to the Dow Jones industrial average.

The notes are mildly leveraged with a 1.41 times factor and have a 60% barrier on the downside.

"People are doing pure currency plays to diversify. It's decorrelated from equities." - A New York sellsider

"There are two asset classes right now that investors are looking at: gold and currency." - Douglas Borthwick, head of trading at forex execution firm Faros Trading

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