Reprinted from Business Times
Mon, Nov 10, 2008, WHICHEVER way you look at it, an investment fund or note that trumpets a 'protected' stamp is very clever marketing. As recent events have painfully shown, it is a misnomer and the description should be banned from fund or investment product literature.
Protected and guaranteed unit trusts first made their debut in 2000 when the market was rocked by the bursting of the technology bubble. Fund managers who offered them raised billions of dollars, the bulk of which have since matured to a mixed record by now - that is, most of them delivered the capital and no more after 3-5 years.
At worst, those that set out to protect or guarantee 70-90 per cent of investors' capital - on the grounds that a lower level of guarantee allows the manager to take on more risk and deliver more returns - finished at just what they set out to secure. That outcome is disappointing. Who would be happy with just 70-90 per cent of his capital after 3-5 years, when a deposit would have delivered the full capital plus an interest rate, albeit piffling? What's more, the outcome is actually a loss when a sales charge is factored in.
The subscription rate of capital-protected unit trusts in fact pales in comparison with retail structured notes, as investors took to notes even more feverishly. Notes, as you would know by now, are hardly regulated, if at all. Unlike unit trusts, there appears to be no minimum credit rating for underlying securities; little disclosure of what exactly the funds are invested in; and absolutely no disclosure of fees. That opened the marketing floodgates.
But first, back to basics on the distinction between protected and guaranteed products. A protected fund or note relies on the strength of the underlying securities or bonds to deliver an investor's capital. This suggests that the most robust of products would go for the highest AAA-rated securities.
To call itself guaranteed, on the other hand, a fund or note needs an institution to underwrite the maturity value.
A crisis situation like today's illustrates just how illusory protection really is. And the flimsiness of the structure was engendered not only by product manufacturers (fund managers and investment banks) but also by relatively loose regulation.
On the product side, structuring a protected fund in the last few years was a challenge because of the low interest rate environment, particularly in Singapore dollars. So, fund managers and banks trawled from lower-quality credits - with at least minimum investment-grade ratings - to put together a basket that would in aggregate deliver an attractive yield. This included reaching into complex structured debt which also fetched higher yields because of their implicit risks.
The big question - even at that time - was whether there was enough cushion in terms of credit quality to secure investors' principal. As we can see now from various structured products whose mark-to-market values are alarmingly low, the answer is clearly no.
As for regulation, the Monetary Authority of Singapore's (MAS) code for collective investment schemes typically sets a concentration limit of 10 per cent for a single security for unit trusts. With lobbying from the fund management industry, this was loosened for structured funds to one-third. This was arguably something that worked against investors' interests. Diversification helps to preserve principal.
For instance, UOB Asset Management's United Capital Protected Fund Series 3 Sing dollar fund had an 11 per cent exposure to Lehman debt as at June 30. The fund recently matured at just about 90 per cent of principal. The US dollar fund's exposure was nearly 29 per cent. The fund matured at about 73 per cent of capital.
Interestingly, Prudential Asset Management's Yield 15 and Yield 20 funds, whose underlying asset is a collateralised debt obligation (CDO), has not fared too badly so far, considering that CDOs are now widely seen as 'toxic'.
The funds have to date suffered four credit defaults out of a total reference basket of 100 names. Still, as a CDO is structured with 'subordination', which gives it a cushion, the capital is expected to remain intact at maturity in 2010, says Prudential. It remains to be seen whether the expected uptick in default rates will hurt. But based on the structure, roughly 18 names will have to default to breach the capital.
Another Prudential Fund 3Plus has had two credit events: Lehman, and Iceland bank Kaupthing Banki. These have reduced the subordination level to 2.07 per cent. With three years to maturity, Prudential so far does not expect the capital to be compromised.
As for structured notes, it has been a marketing free-for-all. Merrill Lynch's Jubilee Series 9 note, for instance, calls itself protected, but there is little to inspire confidence in the underlying assets. In the product literature, there is little disclosure on the credit quality of underlying securities, let alone what exactly the securities are.
As with most other notes, Merrill's noteholders also rank last in any claim on the fund. In short, no protection.
The use of a 'protected' label obscures the risk-reward proposition of a product, which is further obscured by bankers eager to make a sale. Structured funds and notes are often sweetened with a seemingly attractive initial coupon payout. In many cases, this is actually a return of capital rather than a return on capital, which investors fail to grasp.
But the downside risk is that of your capital dwindling to zero - as High Notes investors have realised to their dismay. That surely is an outcome that is too heavily skewed to the downside to be palatable.
Going forward, as MAS reviews the rules on the marketing of structured products, it would not be a bad thing to bar them from the retail market altogether - along with ditching the 'protected' label. After all, structured products really aren't investments. They are a bet that a set of market conditions will hold - that of normal trending markets with muted volatility. All that has since gone horribly awry.
Mon, Nov 10, 2008, WHICHEVER way you look at it, an investment fund or note that trumpets a 'protected' stamp is very clever marketing. As recent events have painfully shown, it is a misnomer and the description should be banned from fund or investment product literature.
Protected and guaranteed unit trusts first made their debut in 2000 when the market was rocked by the bursting of the technology bubble. Fund managers who offered them raised billions of dollars, the bulk of which have since matured to a mixed record by now - that is, most of them delivered the capital and no more after 3-5 years.
At worst, those that set out to protect or guarantee 70-90 per cent of investors' capital - on the grounds that a lower level of guarantee allows the manager to take on more risk and deliver more returns - finished at just what they set out to secure. That outcome is disappointing. Who would be happy with just 70-90 per cent of his capital after 3-5 years, when a deposit would have delivered the full capital plus an interest rate, albeit piffling? What's more, the outcome is actually a loss when a sales charge is factored in.
The subscription rate of capital-protected unit trusts in fact pales in comparison with retail structured notes, as investors took to notes even more feverishly. Notes, as you would know by now, are hardly regulated, if at all. Unlike unit trusts, there appears to be no minimum credit rating for underlying securities; little disclosure of what exactly the funds are invested in; and absolutely no disclosure of fees. That opened the marketing floodgates.
But first, back to basics on the distinction between protected and guaranteed products. A protected fund or note relies on the strength of the underlying securities or bonds to deliver an investor's capital. This suggests that the most robust of products would go for the highest AAA-rated securities.
To call itself guaranteed, on the other hand, a fund or note needs an institution to underwrite the maturity value.
A crisis situation like today's illustrates just how illusory protection really is. And the flimsiness of the structure was engendered not only by product manufacturers (fund managers and investment banks) but also by relatively loose regulation.
On the product side, structuring a protected fund in the last few years was a challenge because of the low interest rate environment, particularly in Singapore dollars. So, fund managers and banks trawled from lower-quality credits - with at least minimum investment-grade ratings - to put together a basket that would in aggregate deliver an attractive yield. This included reaching into complex structured debt which also fetched higher yields because of their implicit risks.
The big question - even at that time - was whether there was enough cushion in terms of credit quality to secure investors' principal. As we can see now from various structured products whose mark-to-market values are alarmingly low, the answer is clearly no.
As for regulation, the Monetary Authority of Singapore's (MAS) code for collective investment schemes typically sets a concentration limit of 10 per cent for a single security for unit trusts. With lobbying from the fund management industry, this was loosened for structured funds to one-third. This was arguably something that worked against investors' interests. Diversification helps to preserve principal.
For instance, UOB Asset Management's United Capital Protected Fund Series 3 Sing dollar fund had an 11 per cent exposure to Lehman debt as at June 30. The fund recently matured at just about 90 per cent of principal. The US dollar fund's exposure was nearly 29 per cent. The fund matured at about 73 per cent of capital.
Interestingly, Prudential Asset Management's Yield 15 and Yield 20 funds, whose underlying asset is a collateralised debt obligation (CDO), has not fared too badly so far, considering that CDOs are now widely seen as 'toxic'.
The funds have to date suffered four credit defaults out of a total reference basket of 100 names. Still, as a CDO is structured with 'subordination', which gives it a cushion, the capital is expected to remain intact at maturity in 2010, says Prudential. It remains to be seen whether the expected uptick in default rates will hurt. But based on the structure, roughly 18 names will have to default to breach the capital.
Another Prudential Fund 3Plus has had two credit events: Lehman, and Iceland bank Kaupthing Banki. These have reduced the subordination level to 2.07 per cent. With three years to maturity, Prudential so far does not expect the capital to be compromised.
As for structured notes, it has been a marketing free-for-all. Merrill Lynch's Jubilee Series 9 note, for instance, calls itself protected, but there is little to inspire confidence in the underlying assets. In the product literature, there is little disclosure on the credit quality of underlying securities, let alone what exactly the securities are.
As with most other notes, Merrill's noteholders also rank last in any claim on the fund. In short, no protection.
The use of a 'protected' label obscures the risk-reward proposition of a product, which is further obscured by bankers eager to make a sale. Structured funds and notes are often sweetened with a seemingly attractive initial coupon payout. In many cases, this is actually a return of capital rather than a return on capital, which investors fail to grasp.
But the downside risk is that of your capital dwindling to zero - as High Notes investors have realised to their dismay. That surely is an outcome that is too heavily skewed to the downside to be palatable.
Going forward, as MAS reviews the rules on the marketing of structured products, it would not be a bad thing to bar them from the retail market altogether - along with ditching the 'protected' label. After all, structured products really aren't investments. They are a bet that a set of market conditions will hold - that of normal trending markets with muted volatility. All that has since gone horribly awry.
![[Most Recent Quotes from www.kitco.com]](http://www.kitconet.com/charts/metals/gold/t24_au_en_usoz_2.gif)
No comments:
Post a Comment