Corporate Governance and bond markets in China/Hong Kong

This article is on how the corporate governance and corruption issues have affected the high yield USD corporate bond market in China/Hong Kong.

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The Berlin-based Transparency International has released its 2012 Corruption Perceptions Index (CPI). China continues to be ranked low; 80 in 2012, 75 in 2011 and 78 in 2010. However, as compared to the other BRIC nations, it is better placed; with Russia at 133 and India at 94 while Brazil is ranked best at 69.
The Chinese HY USD corporate bond market has seen incidences/allegations of weak corporate governance in 2012. Evergrande, a large Chinese property company, was accused of accounting irregularities as well as corruption with respect to land acquisitions, by a short seller Citron in June this year. The bonds were down, though they quickly recovered and recently rallied significantly. China South City, a small scale property developer focusing on integrated logistic centres, was accused recently of misuse of land. The bonds tanked initially but recovered post the clarification issued by the company that its projects are in coordination with the local governments and as per the government procedures. The controlling shareholder cum Chairman of Glorious Property was accused by the US SEC of insider trading and he resigned after settling the case with SEC by paying some fine. Agile, a better respected Chinese property credit, was in the news after its owner and Chairman was arrested for alleged indecent assault. Further, it informed the investors about the resignation of its CFO, a month after he resigned. Renhe, an underground shopping mall developer, has been a distressed credit after reports on accounting irregularities. The company’s half yearly results showing weak business fundamentals with zero sales and continued non-collection of sales receivables, adding weight to the allegations. This has been the only credit affected while the rest have experienced only short term impact.
Hong Kong is the second best ranked amongst the city/states in Asia (ex-Japan), next to Singapore which is placed at 5. However, Hong Kong’s ranking has declined to 14 in 2012 from 12 in 2011. The year 2012 witnessed the arrest of directors of Sun Hung Kai, one of the largest property companies, for bribery. The legal proceedings are going on.
Corruption is rampant in most of emerging Asia, some allegation or the other keeps cropping up; some serious while some are benign. As long as the allegations do not link to insolvency, the investors seem to be digesting the news.

How to trade Dubai credits in 2013

Dubai bond market outperformed other GCC countries in terms of returns. Dubai did an excellent job in addressing investors’ skepticism about several debt obligations that were due in 2012. As of 13 Dec 2012, CDS spreads on Dubai fell by 51% YTD to ~217 basis points indicating improved investor confidence about Dubai’s credit risk.
Dubai economy does not rely on oil revenues unlike its neighboring country – Abu Dhabi. Dubai primarily generates its revenues from tourism, trades, transportation, and financial services industry. All these industries have performed exceedingly well in 2012 and we expect this trend to continue going into 2013 as well. The tourism industry largely benefitted from unrest in many other regional countries. In addition, many individuals from protest affected countries like Syria, Egypt are buying residential properties in Dubai. This is largely supporting real estate prices in Dubai.
Dubai is viewed as a safe-haven while Syrian civil war and heightened tension related to Israel – Iran nuclear war continue to exert a lot of uncertainty in the MENA region.
We understand that yields have significantly fallen in 2012 for many Dubai based corporate issuers. However, we still find value in select pockets. We believe some of the Dubai based high yield issuers are well positioned to offer attractive returns in 2013. We continue to like bonds issued by Nakheel and Dubai holdings in light of attractive yields and companies’ improving operating performance.
We expect MENA bond market to generate bond like returns in 2013 unlike past two to three years, when it generated equity like returns. This scenario makes bonds of high yielding Dubai issuers even more attractive.

Trading strategy for Dubai banks
Moody’s recently downgraded four Dubai based banks. Bond prices of these banks have declined slightly post this announcement. Although we understand that Moody’s rating action is reasonable in light of deteriorating credit metrics of these banks, we believe bond yields have been incorporating this risk. Despite a significant yield tightening across MENA based banks, Dubai banks trade wider to Qatar, Abu Dhabi, and Saudi Arabian banks.
We do not think this rating action would hamper market confidence in these names as investors are aware of asset quality pressures on Dubai banks for a long time now. The agency’s move did not surprise us. In fact, most of these banks had flagged earlier that their asset quality and capitalization metrics would come under pressure in 2013/2014 owing to poor underwriting during the real estate crisis of 2008. We also believe that the UAE central bank’s decision to restrict lending to government and government related entities is a long term credit positive and would enable banks to manage their asset quality in the long run.
Dubai based bank issuers are expected to benefit from strong economic growth in the region, possible government support owing to systemic importance, and strong investor demand. We believe these issuers would not have any difficulty in accessing debt market when needed.

New issuances in Asia HY credit markets and China property space in Feb 2013

This article is regarding the primary credit markets in Asia and slowdown witnessed in new issuances from the Chinese developers in the HY space.

 

The month of February has seen few junk bonds from the China property sector. Glorious Property Holdings Limited, issued USD 250mn senior unsecured notes maturing in five years with a coupon of 13.25% at par (bonds are rated Caa1 by Moody’s and B- by S&P). The company’s stated use of bond proceeds is to refinance existing debt and for general corporate purposes. There was no perpetual issuance by any property name during the month. There was not a single issuance from Indonesia high yield (HY) property space.
CIFI Holdings, a Chinese property developer, had plans to issue USD-denominated senior notes. The company had hired Citigroup, Deutsche Bank, HSBC, RBS and Standard Chartered to arrange fixed income investor meetings. It marketed 5 year maturity USD-denominated senior notes at low to mid 11%. The proceeds were to be used for refinancing debt, acquisition of new projects and development. However, it cancelled its proposed bond sale, citing unfavourable market conditions.
Far East Consortium International Limited tapped the bond markets in February 2013. It is a small-sized Hong Kong based company with a long track record of operations. The company issued dimsums of CNH 1 billion with a maturity of 3 years and coupon of 5.875% at par (equivalent to a yield of 5.875%). This dimsum bond is a small sized issuance and the deal received high subscriptions from the fixed income investors. The company had earlier planned a USD bond issuance in Nov 2012 which got cancelled then.
February 2013 has been a stark contrast to January 2013, which was a month that saw huge supply in the primary markets in the Asia fixed income space. There was a record amount of issuance from the China property high yield sector. The flow of issuances started with Country Garden Holdings Company Limited and Kaisa Group Holdings Ltd, which issued USD 750mn 10 year maturity notes and USD 500mn notes seven year maturity notes. Even issuers rated in the CCC rating bucket such as Hopson Development Holdings Limited, Powerlong Real Estate Holdings Limited and Greentown China Holdings Limited had tapped the bond markets in January.
Yanlord Land Group Limited is one of the few Chinese property credits not to have tapped the USD debt capital markets in 2012 and 2013. The company recently announced its financial results for 2012. The company witnessed a 15% YoY increase in revenues in 2012. The company’s profitability improved while the liquidity position also looks adequate. The company’s total debt outstanding and net debt declined significantly resulting in an improvement in its credit metrics. Moody’s upgraded Yanlord’s rating outlook to stable from negative while affirming its Ba3 corporate family and its B1 senior unsecured debt ratings. The rating action was driven by Yanlord’s strong performance (both operating and financial) during 2012.
Most of the Chinese companies will announce their 2012 annual results in March 2013 and the Asian secondary bond markets are likely to be active, with these data flowing in.

Should you invest in gold now?

In previous article, we listed options available in order to gain exposure to gold. This article discusses the relationship of gold and currencies and how gold can help investors hedge against the fall in the value of currencies.

 

All the transactions in the financial systems and capital markets have two fundamental features. Firstly it involves two parties who are willing to and capable of making an exchange of assets, and secondly an exchange value of the assets. At all times, exchange value is measured in currency; hence the value of the currency itself becomes very important in trading and investing. However, currencies do not have any intrinsic value; they are just promises by the Government agreeing to pay a certain amount as printed on the paper money. Hence all the transactions are based on the trust that government will honor its promise. It is the duty of the government and policy makers to ensure the value of currency does not erode or increase drastically due to unwarranted reasons. A decline in currency, when all other things remain same, would lead to decline in the value of the asset. Considering the ongoing crisis in US and Euro countries, it has become difficult to assess the ability and integrity of policy makers in retaining the value of currencies. Hence it is crucial that a part of currency savings is kept in hard assets such as gold.
During 1940s, most of the developed countries adopted gold standard, and their currencies were based on a fixed rate of USD 35 per ounce of gold. All the currency printed by governments in these countries was backed by gold, officially making it storage value of money. However, there is limited amount of gold in the world (171kt at 2011-end) and most of it being already mined; the supply side remains negligible when compared to the demand. At times of high inflation, when the value of currencies drops, the governments were expected to increase their gold reserve in order to maintain the gold standard. This rigidity of gold finally led to abandonment of gold standard and switching to reserve based currency system. By 1980s most of the countries made the transition from gold standard to fiat currency system, causing the economies all over the world to run basically on trust in the Governments, which in turn put its trust in banking systems. Logically, the capital markets shined better than gold during 1980s to 2000, outperforming the gold. However, during the past decade, there has been gradual increase in the failure of government in honoring their debt and also volatility in the markets. The investors who had kept a part of their savings as investment in market were penalized when the market declined post 2008. The investors have become more skeptical of the actions of Central Banks and Governments in the recent years, considering the failure of the system to protect the interest of investors. Slowly, this has led to gradual accumulation of gold by retail investors who found it prudent to have a part of their assets in gold rather than paper currencies. Off late, even Central Banks have started accumulating gold in order to retain the value of their own currencies. Central banks which held ~36 kt in 1979 gradually reduced its holdings to ~30kt by 2000. Post 2008 they have increased their holdings by 4.3% in a span of four years raising the holdings to ~31.5kt. This shows the deepening of the belief in gold as the store of value.
While certainly most economies would not allow the entire fiat system to fail, it is quite necessary to hedge any loss of savings due to in devaluation of currency. Currently only 16% of the money in circulation is backed by gold and amount of gold in the world is more or less fixed. The price of the gold varies mainly with the sentiment of the investors. During 2012, gold fell by 12% and continued to fall in 2013 mainly due to increased optimism in the market. However, unless some action is seen both at US and Euro-zone, optimism is mere speculation and gold could bounce back. At the current low levels, gold looks attractive compared to other asset classes and it is advisable to buy on dips and accumulate gold during 2013. In the case of economic crisis, the holders of gold can be assured that their savings does not erode due to devaluation of currency or due to inflation.
Another school of thought upholds that majority of gold’s demand is speculative demand and would eventually bring the price down to very minimal amount. The demand for gold for industrial purpose is less than 10% and rest 90% pertains to demand for gold as store of value. If and when there is a policy change restricting the holding and exchange of gold, the price of gold could fall drastically, factoring in the 90% fall in demand. While lot of options are available for gaining exposure in the gold, a good financial advisor would help investors better understand the risks associated with each of them. Prudent wealth management strategies would involve a well planned entry into and exit from gold.

Diversify your portfolio by gaining exposure to the hard asset “Gold” -

Why and How?

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Retaining capital at a time when value of money is quickly eroding has become one of the toughest tasks in wealth management. While deposits, savings bonds, stocks, fixed income bonds, and commodities are the most common ways of investing, estate planning and investing in precious metals such as gold and silver are the well-known strategies to retain wealth in the long run.
Gold is one of highly sought-out hard assets which is considered to be safest investment bet at the time of turbulence and high volatility in the market. Gold has been historically used to measure the value of money and is considered store of value of money. Until some decades ago, gold was used as the basis for issuing currencies in most of the economies. However, with the abandonment of gold standard, now only a portion of the paper money is held against gold globally. Currently, half of the demand for gold comes from consumption as jewellery and technological appliances, and rest half is driven purely by demand for investment purposes such as bars and coins, ETFs and similar products, and OTC investment and stock flows and demand by Central Banks. In many cultures across globe, consumption of gold as jewellery or gifts have the hidden agenda of holding gold as household savings, for rainy days. This leaves us with less than 10% of the gold being actually consumed in electronic goods while the rest is being held as investment (or savings) globally. This phenomena and the high exchange value that this metal commands justifies it being the store of value as compared to paper which is an undertaking of a certain value by a specific country or economy.
Apart from helping investors in retention of value, Gold has proved to be one of the highest returns yielding asset historically. The price of gold appreciated (read spot price of gold commodity in USD) by 350% from 2002 to 2012. The increase in risk associated with other assets, such as stocks and bonds drives the price of gold and hence investing in gold not only provides diversification to the investment portfolio but also acts as an insurance against adversities and uncertainties in the financial market.
Gold is a tradable commodity and can be traded over the counter in commodities exchanges. Investors can choose to trade in gold and gold futures without the physical delivery i.e. holding the gold in its physical form. Other than trading in gold as commodity investors may choose to invest in gold exchange traded products such as exchange-traded funds (ETFs), closed-end funds (CEFs) and exchange-traded notes (ETNs) which follow the movement in gold prices. Not all the funds hold physical gold and generally track gold prices to provide returns closely corresponding to the yield of gold. One of the most popular gold ETF is “SPDR Gold Share” which is backed by physical gold. The gold is held in the name of the owners of the ETFs and hence even if the trust which operates the ETF or the custodian of gold goes bankrupt, the owners of ETFs still have claim on the physical gold. This is one of the easiest ways to invest in gold as it is backed by physical gold and yet the investor need not worry about the risk associated with holding the gold. Retail and small investors, who do not have huge resources to invest in ETFs or other funds, could look at investing in stocks or bonds of gold and other precious metals’ mining companies.
However, prudence must me maintained while investing in either gold, ETFs or gaining exposure to mining sectors. The prices of gold are highly volatile and driven by macroeconomic environment and the returns vary based on the entry and exit point of investment. In choosing the gold based funds, it is important to understand the funds’ strategy, their performance, commission and fees charged. And in case of exposure to mining sector, it is of utmost importance to understand the business of the mining companies, their location and socio-political condition of the economies in which the mines are located. A good financial advisor would be in the position to help his clients in investing gold based on the understanding of the above factors and matching them to the requirement of the clients.

Solvency II and its impact on existing subordinated bonds of Insurers

Solvency II has been delayed historically, and was earlier planned around 2010. Thereafter, it was delayed till 01 Jan 2013, but again got stretched for one year to 01 Jan 2014. Now in a current development, it is expected to start somewhere in 2016. In the UK, the initial deadline of 2013 is now extended until 31 Dec 2015.
The applicability of Solvency II is dependent upon adoption of Omnibus II directive. The legal power of Solvency II depends upon agreement of Omnibus II by all the three European institutions – European Parliament, European Commission and European Council. The vote on Omnibus II which itself got delayed to November 2012 is now further delayed to March 2013.
We consider the delay in implementation of solvency II as a great risk in the current low interest rate environment. In a low interest rate environment, due to low risk free rates the present value of liabilities goes up. At the other end scarcity of high yielding assets would compel insurance companies to invest in risky assets, thereby increasing the overall risk profile of investments. If the insurance companies try to lock the long term yields on the government bond, then again there is duration risk if inflation kicks in.
The overall returns are dependent on timely implementation of Solvency II, and there are no clear signals on it. As per Reuter’s, it is now expected to go beyond 2016. Implementation becomes complex as the readiness varies from country to country and insurer to insurer. As per a report, 70-90% of British, Dutch, Greek, Polish and Spanish insurers expecting to be ready by Jan 2014, but only 60-70% of Belgian, French, German and Italian insurers will be ready by that deadline. The delays are on account of cost associated with implementation of Solvency II, which has a potential to push pension funds into bankruptcy. Majority of the costs are associated with technology related needs for data governance.
Risks are further expected to increase on account of grandfathering arrangement that would continue to allow the pre-existing subordinated debt as capital, while applying the new rule on the new issuances only. A grandfathering provision would allow insurers to keep subordinated debt as capital till a specified period of time, after which it no longer qualify as capital as therefore could be worth a call. If the grandfathering period is say for a 8-10 years period, then the incentive to make a call goes down for an insurer.
However, there is a high likely hood that in order to match the duration of assets and liabilities, the stronger insurance companies in the market would come forth to replace their subordinated bonds with newer instruments eligible as capital. Also, funds with exposure to equity in their asset portfolios are expected to benefit in a QE driven environment. In this manner, both the assets and liabilities would be in line with the current interest rate outlook. Therefore, investment in subordinated bonds with a nearing call date would reduce the overall risks. The modified duration of 2.6 years for the given fund is attractive in this regard. But duration is based on assumption of call option which depends on progress on Solvency II implementation. Overall, we can expect a call on expensive debt pieces, with high coupon. The fund has a coupon yield of 7.9%, a healthy rate by European standard. Therefore the likely-hood of a call goes up irrespective of a requirement to meet Solvency II, as it would help in matching of asset and liability duration. Furthermore, the discount on these bonds makes them attractive at their higher coupon rates.

Global Bond Markets

Global bond markets in the last six month have been defined by monetary easing stance by central banks across the developed world. The central banks in the EU, the US, Japan and UK continued to expand their balance sheet through easing of monetary policies. The additional money created through these measures flown into bond markets thereby increasing the liquidity and pushing the yields to historically low levels.
Within EU, the bond yields were historically highest during the last quarter of 2011. This led ECB to initiative LTRO in two phases in December 2011 and February 2012, respectively. LTRO supported the banking system with cheap loans with a 3 years maturity. The total LTRO loans were approximately €1 tn. LTRO led to a rally in the bond market on account of declining risk premia coupled with liquidity. The effect of LTRO started to fade after the first half of 2012. Greece election failed to conclude a result after the first vote. In addition, negative signals started to arise from Spain, causing the yield on its bond to rise to historical levels. Spain was badly hit on account of its troubled banking systems. Concurrently, investors lost confident on Italy, the next in line, leading to higher yields on its bonds as well. ECB sensed the direness of situation, and then Mario Draghi came up with its commitment to do “whatever it takes to save EURO”. The yields for Spain and Italy came down after this statement. Spain also received a €100 bn bailout package to support its fragile banking sector. This instilled further confidence in Eurozone. Yields for corporate issuers across the Eurozone benefited from this move, leading to record new issuances. In order to provide some concrete measures to support his words, Mario Draghi unveiled outright monetary transactions (OMTs). OMT stipulated that ECB will support the yields of country applying for a bailout to European stability mechanism (ESM), which was subsequently ratified by the German constitutional court. ECB also clarified that it would buy bonds at the near end of yield curve, i.e. within three years maturity. This ensured that monetary policy stays uniform across the Eurozone and issue of financial fragmentation is addressed properly. Meanwhile, the US came up with its QE3 to bring down its mortgage rates.
These measures on a combined basis have led to a rally across the Europe, making European high yield notes one of the best performers in terms of returns. With these measures in place and elections in Germany due in 2013 we do not expect any volatility in the Eurozone bond markets in the near term. In addition, efforts are underway to create a banking and fiscal union, but that might take a while before adding any tangible benefits are seen.

Trading and Investing in Eurobonds

Diversifying one’s portfolio does not mean investing in different sectors or different financial products alone. A fixed income portfolio could be invested in different currencies and different countries mitigating the downside risks associated with a single currency or country. Investing in Eurobonds gives such an opportunity to the investors.

Eurobonds are bonds issued to investors outside the home country, denominated in non-domestic currency. They have a specific structure as identified by the EU directives. The Eurobonds are not necessarily being issued in the Euro zone, however most of the times the bonds are issued to European markets. Also, the bonds need not be issued in Euro, and are generally issued in US dollar or yen. The bonds are traded mainly in European markets and also traded in markets across the globe, and are available for trading throughout the 24×7. The bonds are generally termed based on the currency they are issued in such as Euroyen and Eurodollar. These bonds are basically of five types depending on their terms and features: Fixed rate bonds, floating rate bonds, subordinated bonds, asset backed bonds, and convertibles. Though the words foreign bonds and Eurobonds are interchangeably used, it should be noted that these are different from each other. Foreign bonds are just bonds issued to domestic market in external currency.

Eurobonds are a way to attract foreign funds into the country and hence in most of the country the bonds are exempt tax. These are attractive to individual investors, as Eurobonds are not subjected to the withholding taxes and are largely free from government regulation. Generally Eurobonds are issued to international entities with sound creditworthiness. These bonds help investors to gain exposure to certain sector or geography, which having any exposure to the currency risk. If a London-based investor wants to invest in real estate sector in China, but without having direct exposure to Chinese Renminbi (CNY), then the investor could buy Eurobonds issued by Chinese real-estate companies. Funds usually operates on mandates requiring them to invest in a category of bonds – investment grade, high yield, sovereign with a focus on geographies such as Asia pacific, MENA, or emerging markets. And hence invest in Eurobonds of these regions.

However, it is important that the investors hire advisors to help them invest in Eurobonds. This is mainly because of the operating structure of the Eurobond market and also the risk associated with Eurobonds. These bonds are first sold in primary market to closed set of investors called syndicate who then sell it to bond investors in secondary market. Since, most of these bonds are held mainly by institutional investors and very rarely by retail investors and more so held for long, the bonds are not liquid. Without financial advisors, it becomes difficult to access the Eurobond market. Apart from the accessibility, the investors need advisors to help them pick the right bonds based on the risk associated with the Eurobonds. To invest in any Eurobond, it is really important to understand the risk attached with the country and sector it operates in. Also, these bonds are influenced by the macroeconomic factors, movement in interest rates, currency rates that will impact the investment in long run.

Tips for Investing in High Yield Bond Mutual Funds

Overview

High yield bond mutual funds are gaining importance these days due to their ability to offer attractive returns and strong diversification benefits. The investment case is also supported by the fact that many investors have suffered huge losses by direct stock investing while these mutual funds have generated equity-like returns with relatively lower volatility.

Although, the name suggests that it primarily invests in bonds rated below investment grade (a.k.a junk bonds), the portfolio risk is minimized because these funds hold a wide range of such securities. Moreover, high yield mutual funds provide better returns than most other conventional bond mutual funds. One other important investment consideration is the lower susceptibility of these funds to interest rate fluctuations compared to investment grade securities, as the former has higher yields compared to the latter. Simply put, prices of high yield bond funds tend to be more sensitive to changes in their issuers’ financial outlooks than to changes in interest rates and therefore can act as a natural hedge against interest rate risk.

Generally, high yield bond mutual fund offers returns equivalent to direct stock investment. These mutual funds are managed by experienced fund managers who have a vast experience in the capital markets. If mutual fund investments are done for a longer term basis, one can get exceptional returns, far more than what can be obtained by just keeping money in the bank.

Investors can invest in a variety of high yield bond funds that are available in the market. Some of the common themes of investments include – 1) high risk – high – return 2) low risk – low return, and 3) the medium risk – medium return. Interestingly, even low risk – low return funds have potential to general substantial return on investments. On the other hand, the main disadvantage of these investments is that lower interest rates do not always result in higher prices of the HY bonds.

Basic steps to follow

Although, investing in high yield bond mutual funds is not very common with individual investors, the steps that need to be followed while investing do not differ much compared to the traditional mutual fund investing.

Investors need to go to the office of the mutual fund provider and meet with investment managers. The manager typically explains the advantages and disadvantages of every fund. Investors and managers can finalize the investment policy statement as per risk appetite and return objectives on investors.

The final stage is security selection. Investors can select a few funds and invest in a fund, which has a good reputation in the market and has given consistent returns to investors over a time.

One important consideration for investors is to remember that these investments are affected by market risks. It is a common phenomenon that investors may see volatility in the investment value and might see negative returns on their investments in the near term. That said, as market conditions improve, these funds rise in value notably.

Why should an investor opt for structured products?

In their quest for higher returns in today’s low interest and volatile environment, investors find structured products very appealing. But there could be certain pitfalls – counterparty risk, liquidity, transparency regulation?

Structured products are market linked products that provide an investor with tailored risk-reward combination. An investor’s goal could be principal protection, income stream, enhanced return, diversification, market access, tax efficiency and hedging. For instance, institutional investors use structured products in order to enhance portfolio returns while limiting the risk of capital loss. Structured products are available based on all market sentiments – bullish, bearish, sideways, high volatility and low volatility. One of the biggest assurances of these products is the protection of capital. Structuring can be done through a mix of variety of financial instruments (stocks, bonds etc), commodities, currencies and other asset classes, and their derivatives. The capital protection is typically insured through the use of fixed income instruments, with additional return generated through the use of derivatives. A typical structuring could be a zero coupon bond and equity derivative. An investor paying say $50,000 would be typically paying for the zero coupon portion and the equity derivative. At maturity the zero coupon bond will reach its face value (typically pegged at initial amount paid) of $50,000 and extra return would be conditional upon exercisability of the attached derivative.

Risks associated with structured products

While there seem many prospects associated with returns generated by the structured products, in reality, buying a structured product exposes investors to the credit risk of the issuer – as they typically end up providing unsecured credit to the issuer. Structured products are not exchange traded, and needs to be purchased from the issuer itself – a great counter party exposure. Therefore, it is very important to assess the credit standing of the issuer, as the principal protection depends largely on it. The assets are not ring fenced on the balance sheet of the issuer. Lehman is the biggest example in this regard, as it was a large issuer of these products. Another risk is with regard to the market itself, as even through the investor is able to receive the initially invested capital at maturity; the returns adjusted for inflation could be negative. In addition, risk related to derivatives is already packaged into a structured product. Based on the type of structured product, the capital protection may not be complete. If investor sells it before maturity then there is a high probability of loss of capital protection, in addition to loss of conditional payout. Therefore, liquidity is also a major concern, as smooth exit before maturity is not possible.

So who should invest in structured products?

There are no actual parameters to define a structured product investor. Structured products are by and large opaque and therefore require great appetite for risk, as retail investor’s ability to price them accurately is limited. Complex derivatives associated with these products make them esoteric for retail clients and distribution people can’t be expected to know more than the creator of these products. However, current low interest rate environment in the developed world coupled with stock market volatility increases their relevance there. Products are usually tailored for high net worth clients with an appetite for risk-reward.  Therefore by nature it’s a product for wealthy ones and bigger institutions. In case of retail clients, age becomes even more important, as it could allow for more risk. This is true for Asian millionaires who are rich and young. One metrics to judge the safety could be the strength of regulation on these products. But ever increasing complexity of these products has a potential to even beat the regulation.