Safety in numbers
Structured investments use risk and reward combinations to offer both capital protection as well as income, writes Chris Davis
Sermon Kwan ING Asia Private Bank Managing director, head of Greater China; Helen Ng JPMorgan Private Bank Managing director
AS STRUCTURED PRODUCTS continue to make rapid inroads into Asia, investors are looking for more diverse products to meet their appetite for greater leverage, or to enhance yields and preserve capital.
Unlike traditional investments such as stocks and bonds, structured products are synthetic investment products that use derivatives and other financial instruments to create new risk and reward combinations that are not available with more traditional direct investments.
Sermon Kwan, managing director, head of Greater China, ING Asia Private Bank, says structured investment products are opening new doors for investors looking for both capital protection and income. He says there is keen demand for equity structured products either linked to an individual stock, a basket of stocks, or indices. There is also widespread interest in structured products with underlying assets invested in commodities.
'The beauty of structured products is that they can be tailored to meet a wide range of investment solutions, risk profiles, investor perspectives and strategies,' he says.
Depending on the structure and underlying issues, structured products can be 100 per cent principal protected, partially protected or totally open. 'Structured products cover such a wide variety of underlying exposures, tenures, return profiles and other combinations that they are easily customised to accommodate any new market environment or investment appetite,' Mr Kwan says.
Popular structured investments, such as discount certificates, allow investors to acquire exposure to certain underlying securities, basket of securities or index with an entry price that is lower than the market price. The discount is given in exchange for the part of potential profits, which is the amount above a predetermined maximum price or cap.
As a vehicle to manage risk, discount certificates allow investors to obtain market exposure without directly investing in the underlying business itself. Portfolios with a wide spread of underlying investments across all the asset classes of cash, bonds, shares, property and the derivative markets are usually better placed to weather market volatility.
Although no minimum redemption is guaranteed, this structure makes this product ideal for investors who have a positive yet conservative mid-term view on the performance of the underlying assets and at the same time want to protect themselves against market fluctuations.
'Discount certificates improve the risk and return profile of the underlying security in a very flexible and efficient way, making them an ideal instrument for investors to better manage their equity portfolios,' Mr Kwan says.
With analysts predicting that for the time being base rates will remain flat, the more risk-averse investor may look to allocating more of an investment portfolio to cash-alternative structured products that allow for short tenure, typically one year or less. This strategy can also provide capital protection at maturity while enabling participation in the underlying market of choice such as commodities, equities or interest rates.
Ultimately, Mr Kwan says, investors should have an opinion on the type of structured products they are investing in, and be able to assess the maximum and minimum returns that can be expected. And, if this is not the case, investors should be very sure about the proposition they are considering.
Helen Ng Man-yee, managing director, JPMorgan Private Bank, says structured products increasingly form an integral part of the bank's private wealth management asset allocation solutions offered to private clients. Typically, this is about 20 per cent of a balanced portfolio.
She says among structured product choices, structured notes have become one of the popular options. Structured notes pay a return linked to the performance of an underlying benchmark such as interest rates, equity markets, commodities, corporate credits or foreign exchange markets.
A structured note can also be constructed in such a way that the principal is protected up to a certain percentage, or not at all. The principal is not protected, however, if the note is sold before maturity. 'A principal protected investment may be appropriate for investors unwilling to risk their principal or who have long-term financial obligations,' Ms Ng says.
Structured notes can also include a buffer zone. These are appropriate for an investor who is comfortable taking some downside risk, but would like a 'buffer' to mitigate or moderate losses. With a downside buffer, there can still be interest payable even when the shares have negative performance (provided the negative performance doesn't exceed the downside buffer).
In exchange for risking their principal, the investor would have greater upside potential relative to a fully principal protected investment. In general, investments with buffer zone components have a shorter maturity than principal protected investments, often between two and four years. Investors are also choosing structured products in different sectors that have no relation to each other.
'Investors might choose ... energy, luxury goods and financials, which generally have no correlation to each other,' Ms Ng says.
Another strategy gaining in popularity is 'two-stock auto-callables'. This type of investment involves choosing two stocks and committing to holding them for fixed periods, frequently two years.
The volatility play requires the investor to select a fluctuation range the stocks trade within. Providing they remain in the predetermined range they can generate higher returns based on risk and investment than holding single blocks. Increasing the number of stocks also increases the risk of volatility even within the same industry or finance sector. Increasing the number of stocks across sectors also increases the risk of one or more of the stock holdings trading outside the predetermined range. Considering the risk involved, an investor choosing multiple stocks as an auto-callable strategy will find a safer investment format investing in a stock index.
Lim Leong-guan, managing director and head of product development Asia (transaction products) UBS Wealth Management, says because of better education, investors are now more aware of the value of structured products.
He says that depending on where high net-worth investors are placed in their lifecycle determines their risk profile. 'We have clients who are focused on growing wealth and those who are more interested in preserving wealth,' Mr Lim says. He adds that properly tailored structured products work equally well with both conservative and aggressive strategies.
Investors are also looking for shorter maturity products. 'In the past we were seeing clients taking position with eight to 10-year structured notes, but this has been pulled back to two or three years,' Mr Lim says. Shorter tenure structured notes are less sensitive to interest rate rises.
Mr Lim has also noticed a growing interest in 'stock accumulator' also known as 'discount security purchases' or 'knock-out discount accumulator investments'. The accumulator strategy focuses on regular (usually daily), accumulation of a stock at an entry level lower than the price of the stock at the start of the term of accumulation. The accumulation of the stock at the pre-specified entry level continues until maturity or if the stock rises to a predetermined knock-out level (before maturity) when the accumulation stops and the investor may elect to take a profit based on the accumulated position.
Gary Tiernan, managing director and head of product management and investment solutions for private wealth management at Deutsche Bank Asia-Pacific, says investment in structured products has grown dramatically over the past five years and has become an important investment option.
He says one of the main indicators of this is that most of the private banks have a team of product assessment people, in the same way that for a long time they have had a team of people who assess which managed funds they are going to sell. Along with an increase in the investor base in Asia, there has been an expansion of innovative structured products offering more exposure to asset classes such as commodities, credit and equity markets. Over the past year, investors were mainly focused on equity investments.
'The fantastic thing about structured products is the layout, which allows the return scenario to be seen with great clarity. With the help of a good adviser an investor would know the variable factors that can affect the performance,' Mr Tiernan says.
This is accomplished by creating a 'basket' of investments that can include bonds, equities, commodities, currencies, real estate trusts and derivative products. The mix of investments in the basket determines its potential upside, as well as downside protection, time horizon and other considerations. Mr Tiernan says there is no indication that the interest in structured products is slowing down. 'I expect structured product providers to continue to find new ideas and ways of entering different markets which will represent positive opportunities for investors.'