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How far can the "snowball" roll?

Fang submitted 2021-06-18 20:00:41

How far can the "snowball" roll?

In the era of low interest rates, investment banks and asset management businesses continue to innovate, and summing up relevant experience can provide considerable experience for the transformation and development of asset management institutions and even commercial banks. As one of the series of reports, this article focuses on the business opportunities of "snowball" type asset management products.

1. Structural design:

In line with the decline in equity market volatility, "Snowball" products are at the right time: Since the second quarter of 2020, "Snowball" products have been popular in the Chinese market. The average monthly sales amount of some head managers has reached 2 to 3 billion yuan, which reflects the essence of the market's increasing demand for absolute income.

(1) High winning rate and non-linear returns

Snowball products are subject to "knock-in" and "knock-out" within the time limit to determine product revenue. Take the “Snowball” product with a knock-out price of 105%, a knock-in price of 75%, and a CSI 500-target as an example. From 2015 to 2019, 71% of the contracts were knocked out in advance, and investors received an annualized positive return of 15%; 25% of the contracts suffered losses, and the average total loss during the contract holding period was 23.4%; 4% of the contracts were held to maturity, and investors received an annualized return of 15%. On the whole, 75% of the contracts have reached an annualized return of 15%, and the return characteristics are somewhat similar to traditional non-standard assets.

(2) Additional rigid redemption of income certificates

Income certificates of asset management institutions are on-balance sheet liabilities. The asset management agency is responsible for the redemption of principal and interest and has statutory responsibilities for it. Since it is an on-balance sheet liability, the income certificate is "constrained" by the balance sheet, and there is not much room for regulatory arbitrage. Therefore, income certificates of asset management institutions are “capital-guaranteed” assets that meet regulatory requirements.

Investors make money with low volatility.

For investors, if the underlying asset continues to fluctuate in a small range, it is more conducive to obtaining the agreed annualized return.

(1) Shocking market: In the most ideal situation, the stock index fluctuates frequently but does not deviate from the "knock-in and knock-out" range, and investors and institutions will achieve a win-win situation. Take the “snowball” products mentioned above as an example. From 2016 to 2018, it was a turbulent market. There was no “knock-in and knock-out” of these products. The holding maturity annualized rate of return is 15%, and the probability of occurrence is 5.8%.

(2) Bull market: Investors may trigger knockout points in advance, so they can only obtain fixed income during the holding period, which is not cost-effective compared to shock markets. For example, in the bull market from April to June 2015, the product was knocked out in advance, and the average holding period return was only 1.22%. According to historical data, the probability of occurrence of this situation is 57.7%.

(3) Bear market: The market unilaterally downward triggers knock-in, and investors will bear all losses. For example, in a bear market from 2017 to 2019, the average annualized return of the product is -7.82%. According to historical data, the probability of occurrence of this situation is 36.5%.

Asset management institutions obtain management fees and transaction income. For asset management institutions, the issuance of "snowball" products has three benefits:

(1) Management fee: "Snowball" products are mostly issued at R4 or R5 level, and the management fee generally reaches 1.5%;

(2) Benefits of Swing Trading: The agreed annualized rate of return of Snowball products is essentially the hedging cost of the asset management agency to hedge risks. Asset management agencies will frequently trade the underlying assets during the product's existence, and use the proceeds from volatile market transactions (buy low and sell high) to cover the cost of hedging. The income higher than the cost of hedging is the income of the asset management institution. According to a publicly available quantitative report of asset management institutions, an asset management institution with a winning rate of about 65% to 70% can achieve an annualized return of more than 15%.

(3) Unilateral market gains: in a bull market, the market moves up unilaterally, triggering a knockout. If the annualized income held by the asset management institution exceeds the agreed income of the product, the excess income will all belong to the institution. Institutions in a bear market do not need to pay agreed income, and at the same time do not have to bear the loss of the underlying asset.

2. Scale

Since the second quarter, the scale of new issuance of "Snowball" products has increased significantly. In the first quarter of 2021, with the gradual cooling of the equity market, the market has entered a volatile market since the second quarter (the volatility rate of the CSI 500 in the first quarter was around 22.83%, which was a large range; the volatility rate in the second quarter fell to 7.22%), which provides an opportunity for the issuance of "Snowball" products. According to data from the Financial Associated Press, as of May 2021, China Merchants Securities has sold nearly 3 billion "snowball" products this year, with an inventory of about 3.5 billion (non-capital guaranteed structure, excluding small “Snowball" and other principal-guaranteed products). Minsheng Securities has successfully issued multiple phases of snowball structure products from the second half of 2020, including Minsheng Taxue Bank asset management series, with a cumulative scale of over 100 million.

It is estimated that the market scale of "Snowball" products is about 150 billion yuan.

Snowball products can be registered in income certificates or OTC options. According to data from the Securities Industry Association, as of the first quarter of 2021, the existing scale of income certificates totaled 411.61 billion yuan, of which 35% were non-fixed income. The estimated snowball product scale was about 72.03 billion yuan. In addition, the amount of over-the-counter financial derivatives remaining in the market is approximately 811.76 billion yuan, of which 47.58% are stock indexes. Assuming that about 20% of them are snowball products, the scale is about 77.28 billion yuan. Through the calculation of the above two channels, the total scale of "Snowball" products is about 150 billion yuan. If a more radical assumption is given, the current maximum possible market size of "snowball" products is about 500 billion yuan. Calculated based on the requirement that the income certificate does not exceed 60% of the net capital of the securities company (at the end of 2020, the net capital of the securities industry is about 1.8 trillion yuan), and the requirement that the scale of the OTC individual stock options business corresponding to proprietary equity securities and the derivatives shall not exceed 50% of the net capital (operating business for 3 consecutive years and continuing to comply with regulations), the possible maximum scale of the "Snowball" product is about 2 trillion yuan.











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