Fri, 10 Apr 2020
SINGAPORE: A popular investment among Asia’s wealthy in the years of rock-bottom interest rates has been upended in the recent market rout, leaving investors facing losses estimated to be in the billions of US dollars.
Structured products called fixed coupon notes attracted scores of private banking clients in Hong Kong and Singapore in recent years, according to half a dozen bankers and advisers Bloomberg spoke with.
Promised regular coupons even in turbulent times, some put 20% or more of their portfolios into the instruments, they said. One catch: the principal was tied to swings in assets like stocks, and losses could mount quickly during deep market declines.
About 5%, or more than US$80bil, of Asian private banking assets outside mainland China is probably tied to such notes, estimates University of Hong Kong Professor Dragon Tang.
They worked smoothly until Covid-19 struck. The promised payouts have since been dwarfed by capital losses as stocks slid and some leveraged holders were forced out of the illiquid notes. Others are hanging on, hoping a turn in sentiment restores their value.
“In a bull market, investors keep collecting coupons on these notes and they feel it’s a great investment, ” said Rahul Banerjee, an ex-Standard Chartered banker and founder of BondEvalue, a fintech that offers bond pricing services to investors.
“When the market turns, they get stuck with unimaginable losses, ” he said, estimating wealthy Asian investors are seeing losses in the billions of US dollars.
The products work well in a rising market or one moving sideways, where investors recover the initial investment and the coupon owed, which could be as high as 12% per annum.
But the interest-bearing notes, linked to the performance of underlying assets, open holders to the risk of steep losses if those assets fall below a preset level.
Some leveraged investors have been forced into selling early at steep discounts, according to investors who asked not to be identified speaking on private matters.
The loan-to-value offered for structured products including fixed coupon notes was over 50% on average, the people familiar said, though lending terms are being tightened given recent margin calls.
Those that continue to hold the notes may see their investments recoup losses in a market rebound.
After sinking 21% in the first quarter, the MSCI World Index has risen about 3% in April.
“Investors of structured notes are essentially writing put options, ” said Mary Leung, head of advocacy for Asia Pacific, CFA Institute, referring to derivative contracts where the seller agrees to buy an asset at a specified strike price.
“In Asia, higher retail participation in markets, the difficulty of accessing bonds and the hunt for yield drive the popularity of such products, ” she said.
One Singapore-based financial services professional, who asked to remain anonymous, lost between 30% to 40% of the US$400,000 he invested in fixed coupon notes tied to shares including Microsoft Corp, Broadcom Inc and India’s ICICI Bank Ltd.
The notes offered a coupon of about 10%, paid quarterly with a one-year maturity.
He sold the investment, which was leveraged up about 60%, prior to maturity after receiving margin calls and deciding he didn’t want the stress of monitoring daily prices and worrying about fresh calls from his bankers.
A second investor, who heads a family office in Singapore, said about 10% of his financial holdings were in notes offering yields of between 6% to 12%.
Those tied to energy and the automotive sector were in the red at the end of March, he said, though he remained invested in hopes of a recovery over the next few months.
Such products don’t offer good risk-adjusted returns, said Professor Tang, who has researched the 2008 implosion of structured notes called Lehman minibonds, which led thousands of Hong Kong investors to protest outside bank branches.
Disclosure rules have tightened since then and investors are now better-informed, he said, though there could still be some mis-selling.
New rules following the collapse of Lehman Brothers Holdings Inc included narrowing the scope of qualified investors - who must have about US$1mil to invest in Hong Kong and US$1.4mil in Singapore - and categorising clients into different risk tolerance buckets.
“Given the greater risk exposure of fixed coupon notes, we have de-emphasised the product in recent years, ” DBS Group Holdings Ltd said in an emailed response to questions.
For clients keen on the product, DBS’s bankers recommend structures which include their high-conviction stock picks or incorporate features that “act as safeguards against outsize losses, ” it said.
The attractions of high-yield offerings have been hard to resist.
A 2019 report by Asian Private Banker and Julius Baer Group Ltd. showed structured products made up 11% of client portfolios for independent asset managers in 2018, up from 4% the previous year.
Some 42% of non-exchange-traded investment transactions were in such products, according to a 2018 survey by Hong Kong’s Securities and Futures Commission.
The hunger for yield will persist as an impending global recession prompts a fresh wave of monetary stimulus and companies slash dividends to preserve capital.
- Bloomberg
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