Billions lost in structured notes

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 dollars.

Structured products called fixed coupon notes attracted scores of private banking clients in Hong Kong and Singapore in recent years. Promised regular coupons even in turbulent times, some put 20 per cent or more of their portfolios into the instruments.

One catch: the principal was tied to swings in assets like stocks, and losses could mount quickly during deep market declines.

About 5 per cent, or more than US$80 billion (S$114 billion) of Asian private banking assets outside mainland China is probably tied to such notes, estimates University of Hong Kong's 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 non-liquid notes. Others are hanging on, hoping for a turn in sentiment.

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 cent 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. Those who continue to hold the notes may see their investments recoup losses in a market rebound.

One Singapore-based financial services professional lost up to 40 per cent of the US$400,000 he invested in fixed coupon notes tied to shares, including Microsoft, Broadcom and India's ICICI Bank.

He sold the investment, which was leveraged up about 60 per cent, prior to maturity after receiving margin calls and deciding he did not want the stress of monitoring daily prices and worrying about fresh calls from his bankers.

A second investor said about 10 per cent of his financial holdings were in notes offering yields of between 6 and 12 per cent. Those tied to energy and the automotive sector were in the red at the end of last month, he said, though he remained invested in hopes of a recovery over the next few months.

New rules following the collapse of Lehman Brothers included narrowing the scope of qualified investors - who must have about US$1 million to invest in Hong Kong and US$1.4 million 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 said in an e-mailed response to questions. For clients keen on the product, DBS bankers recommend structures that include their high-conviction stock picks or incorporate features that "act as safeguards against outsize losses", it said.

It is estimated that US$15 billion to US$20 billion of new fixed coupon notes have been issued by private banks in Asia this year.

In South Korea, complex structured products have gained traction among both the well-heeled and retail investors, driving the total outstanding to 106 trillion won (S$124 billion) as of April 1.

Investment banks make money from structuring the notes and try to manage their exposure by passing the risk to other parties.

Such products have "proliferated" in recent years with banks making a strong push as they delivered good revenues, according to Mr Nick Xiao, the Hong Kong-based chief executive of wealth manager Hywin International. Investors liked the tailored features, he said, adding that as long as the risks are clear, there shouldn't be complaints.

Mr Kerry Goh, CEO of multi-family office Kamet Capital Partners, has heeded the risks and stayed away. He puts the more than US$1 billion his firm manages into investments with more transparent pricing and ease of exit.

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A version of this article appeared in the print edition of The Sunday Times on April 19, 2020, with the headline 'Billions lost in structured notes'. Subscribe