Daily leverage certificates hold promise and risks

Mr Keith Chan of Societe Generale thinks that if investors are given the right information, they can manage risk to boost returns.
Mr Keith Chan of Societe Generale thinks that if investors are given the right information, they can manage risk to boost returns.PHOTO: SGX

For financial service industry veteran Keith Chan, it is all about discipline, service and attention to detail.

The head of cross asset listed distribution at Societe Generale's global markets in the Asia-Pacific is responsible for the business development, sales and marketing of listed products, including structured warrants, callable bull/bear contracts (CBBCs), and more recently, daily leverage certificates (DLCs).

In July, Societe Generale was the first financial institution in Asia to roll out DLCs to investors in Singapore and the region.

"The question is what kind of service do you provide? Every investor has his or her individual needs. So you need to put yourself in their shoes - take into account their risk-return spectrum, and make sure they understand the products they are investing in," Mr Chan said.

The Bachelor of Commerce graduate with majors in accounting and finance from the University of Sydney has spent nearly two decades of his career specialising in retail investment products. Prior to joining Societe Generale, the 41-year-old held similar roles at Macquarie Group and HSBC between 2005 and 2014.

"There's a sophisticated segment of the retail investor market that accounts for a good chunk of traded volumes in warrants, but over time, investors (have been) generally demanding simpler products, so DLCs are a good addition to CBBCs and warrants," he noted.

DLCs offer investors fixed leveraged returns of three to five times the daily performance of the underlying asset, and the flexibility of trading in both rising and falling markets.

They are designed to be traded over short periods of time - not longer than a few days - to capture short-term market moves. Some investors even trade them predominantly on an intra-day basis.

The Singapore Exchange (SGX) is the first venue in Asia to offer trading in DLCs, allowing specified investment product-qualified investors to gain fixed daily leverage exposure to key Asian indices.

DLCs come without implied price volatility and time decay - features that impact pricing for options.

There are no margin calls, and investors will never lose more than their initial invested capital.

The first batch of DLCs issued by Societe Generale comprises 10 products, including long and short DLCs, offering fixed leverage of three or five times the daily returns of the MSCI Singapore Index, Hang Seng Index and Hang Seng China Enterprises Index.

ROBUST ASIAN DEMAND

Societe Generale is one of the largest issuers of DLCs in Europe. Over the last five years, DLCs have become the fastest-growing listed products by volume in the continent. The bank has launched close to 700 DLC products across nine European countries, spanning a range of underlying assets, such as foreign exchange, commodities, equity indices and single stocks, Mr Chan noted.

"We see strong demand for leveraged products from the Asian investor. In this region, the short-term trading mentality and appetite for leverage is much higher than in Europe, where investors tend to buy and hold their investments for yield over the medium or long term," he added.

Although DLCs are simple to understand and easy to access, investors still need to be educated on the technical details.

"For retail products, it's always about education, to ensure investors understand the nature and risks. For example, we need to highlight the compounding effect of DLCs - they're designed for day or short-term trading, and not a buy-and-hold for an extended period."

Understanding risk is a key part of the education process, Mr Chan emphasised.

"Risk is not something to avoid, but should be used to work for you. Investors should be clear about how much risk they can stomach, how much of it they wish to assign to their portfolios - in other words, risk is a tool that can be used to boost your investment returns when it is properly managed."

In comparative terms, DLCs are higher-risk products compared with exchange-traded funds (ETFs) or the trading of stocks, but carry lower risks than CBBCs and warrants, he added.

At the end of the day, it is important to ensure the investor has a good experience trading a product, regardless of whether the end result is a profit or a loss.

"How does an investor have a good experience? It means that before buying, he has understood the product, what was involved, and the risks, so whatever happens, there are no surprises," Mr Chan said.

To achieve this, having the right educational tools to convey simple messages clearly and effectively - whether they be website materials, brochures or videos - are essential.

Another key service is how the issuer provides liquidity for each product listed on the exchange. "It means we provide consistency in the bid-ask spreads. For intra-day trading tools like DLCs, this is critical," he added.

Apart from service quality, Societe Generale also places a premium on innovation - using technology, including different platforms and mobile tools to roll out new products.

DAILY LEVERAGE CERTIFICATES

The basic principle behind DLCs is simple - if the underlying index moves by 1 per cent from its closing price the previous day, the value of a 3x DLC will move by 3 per cent, and that of a 5x DLC will move by 5 per cent.

For each underlying leverage level, there is a long and short DLC available.

A bullish investor who thinks that the underlying index is set to rise over the trading day can select a 3x long DLC, which will rise in value by 3 per cent for each 1 per cent rise in the underlying index (before cost and fees).

A bearish investor who expects the underlying index to fall can select the 3x short DLC, which will rise in value by 3 per cent for every 1 per cent fall in the underlying index (before cost and fees).

If the market goes against the investor, the DLC will amplify losses in the same way.

Investors should note that the leveraged three to five times exposure to the daily performance of the underlying index is on the basis of a one-day holding period.

DLCs are generally not suited for holding periods longer than a few days. If held over a period longer than a day, actual returns will deviate from the projected leverage exposure. In addition, even with a one-day holding period, there will be tracking errors due to cost and fees.

DLCs are a specified investment product (SIP).

Under the Monetary Authority of Singapore's guidelines to enhance safeguards for retail investors, brokers must assess if investors have the relevant knowledge and experience before they can invest in SIPs. SIPs are products that have structures, features and risks that may be more complex, and include DLCs, structured warrants, synthetic ETFs, futures and options.

Investors who wish to trade DLCs need to complete a customer-account review with their respective broker.

Alternatively, investors may assess their qualifications to trade SIPs or enhance their product understanding through the SGX Online Education Programme.

•This is an edited version of the Alpha Chronicles, which is a regular column on SGX's My Gateway website that aims to profile best-in-class asset managers in the financial industry.

A version of this article appeared in the print edition of The Straits Times on September 11, 2017, with the headline 'Daily leverage certificates hold promise and risks'. Print Edition | Subscribe