Tuesday 06 Jun 2023
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This article first appeared in Wealth, The Edge Malaysia Weekly on September 26, 2022 - October 2, 2022

Owing to the lacklustre performance of the local stock market in recent years, equity-linked structured products have become popular among high-net-worth individuals.

Embedded with certain features, these products allow investors to capture potential gains from a sideways market while protecting their principal, says Azzahir Azhar, head of investment management at Maybank Investment Bank.

Azzahir, who is also head of equity and commodity derivatives, says such a trend is reflected in the solid growth of the bank’s equity-linked structured products.

“When we started out in 2015, we were doing about RM300 million to RM500 million per year in sales volume. In recent years, the volume has been consistently over RM2 billion per year,” he says, noting that the figures include products sold to high-net-worth individuals and institutional investors who ask for more bespoke solutions with their own desired structures. 

What are structured products and why are they appealing to high-net-worth investors? Put simply, they are financial instruments whose performance is linked to one or various underlying assets through the use of derivatives. In the case of equity-linked structured products, their performance could be linked to a single stock such as Tenaga Nasional Bhd or a basket of local or foreign stocks or stock indices.

One of the most popular structured products in town is the minimum redemption investment (MRI), otherwise known as a SharkFin product. 

MRI’s principal-protected feature is what attracts investors the most. It means investors will at least receive their principal over a specific period. This is typically one to two years if they hold on to the product until its maturity, and as long as the product issuer (or bank) remains solvent. In exchange, investors would forego a huge chunk of their gains when specific conditions are met.

For instance, an equity-linked MRI would allow its investors to participate in the share price appreciation of a specific counter, let us say Tenaga, up until a certain level of 20%. However, once Tenaga’s share price hits 20% or above, MRI investors would only receive a rebate upon maturity and gain just slightly more than their principal.

“Assuming the stock price goes up 1%, you get 1%. When it goes up 5%, or 15%, you get the same returns. But once it exceeds the knock-out level [of 20%], you no longer get participation, but a so-called rebate, which gives you a fixed return [that is] slightly higher than your principal amount,” says Azzahir.

In short, MRI investors would gain rather handsomely from the share price of a company moving within a given range. If not, they would bear the cost of investing in the product and the opportunity cost, which are returns they could generate by simply putting their money in a fixed deposit or other safer investment instruments.

Another popular product in the market is autocallables or KIKO (knock-in, knock-out), says Azzahir.

Investors in autocallables will receive a fixed percentage of income in a given period. This could be monthly, quarterly or semi-annually, as long as the share price of the company is traded within a specific range.

However, when an auto call event is triggered — let’s say, the share price of the company increases by 5% — investors will stop receiving their periodic income and get back their principal plus the coupon income. In other circumstances, investors would have to buy a certain amount of the company’s shares from the bank at a discount.

“There is a term called the knock-in barrier in autocallables. When it is triggered, there’s a chance you may [have to] redeem your investment in shares, instead of in cash,” explains Azzahir.

Can investors redeem their investment early? Azzahir says yes. Maybank will not charge a penalty, but investors would have to bear the cost of the redemption, which depends on market conditions, as derivatives traders are required to unwind their positions in the markets. The issuer will also have to uplift the deposit that it has placed with the money received from investors, resulting in a cost. 

The minimum investment amount for equity-linked structured products is RM50,000. The spread, or the so-called fee, of accessing these structured products depends on how they are structured. In general, it is typically between 0.5% and 2% per annum, says Azzahir.

“Unlike most investment products, structured product investors typically do not pay additional fees on top of their investment amount. Hence, the issuers do not usually realise a fixed spread upfront, nor any management fee across the product’s tenure. Instead, the issuers earn a spread, which is the difference between the price of the product and the cost to manufacture the product.

“The range of the spread is in line with other investment products, typically between 0.5% and 2% per annum. However, in reality, the final spread realised by the issuers varies according to the actual cost [of the products], which can be impacted by market conditions throughout the lifetime of the structured products.” 

It is worth noting that structured products are only available to high-net-worth individuals. The Capital Markets and Services Act 2007 defines them as having a total net investment, whether personally or jointly with a spouse, in capital market products that exceeds RM1 million or its equivalent in foreign currencies.

More structured products manufactured in-house at lower prices 

Besides the underperformance of the KLCI, the pandemic has prompted the affluent and high-net-worth investors to explore more unique products, including structured products, to gain better returns, says Azzahir.

“What happened during the pandemic was an increased interest in investing [among Malaysians]. That permeated through every capital market product. It has helped demand [for structured products as well] in 2020 and 2021.”

Another catalyst is that some banks, such as Maybank Investment Bank, have in recent years started to manufacture these products in-house, instead of distributing those manufactured by foreign banks such as JP Morgan.

By doing so, local banks are able to offer the products at a more competitive price and with more “local flavour”. The products’ performance can be tied to the share price of various local public-listed companies, instead of predominantly foreign names. “Issuers [of these products] used to be non-Malaysian entities with a regional or global presence. These guys are typically the European and American banks that have less interest in local names or companies.

“As for us, we are a regional banking group  that operates locally. We understand the local market very well and, therefore, we are comfortable issuing products over local names and taking on those risks,” says Azzahir.

As at Sept 9, equity-linked structured products offered by Maybank Investment Bank could be tied to one or more stocks — from a basket of more than a hundred local and global public-listed companies. Among the most popular local companies are banks such as Public Bank Bhd, CIMB Group Holdings Bhd and RHB Bank Bhd, as their prices are more stable and shares, liquid. Smaller counters like MyEG Services Bhd would sometimes emerge as a favourite.

“In the past two years, investors like the tech sector, especially the FAANG companies (Facebook, Amazon, Apple, Netflix and Google or Alphabet). China tech companies like Alibaba and Tencent were also quite popular.”

Azzahir notices that investors now seem to favour shorter-duration structured products over their longer-duration counterparts as stock markets are getting increasingly volatile. They are more cognisant of environmental, social and governance (ESG) risks that could affect share prices.

“Year to date, more than 50% of our issuances were over companies with better ESG profiles. Investors are more aware of ESG as a risk factor and are more selective in choosing companies they want to have exposure to.”

Moving forward, Azzahir and his team are looking to launch more Shariah-compliant structured products to cater for demand. Their Shariah-compliant Autocallable-i structured product, the first in the country, won in the Best Structured Product category at The Asset Triple A Islamic Finance Awards 2021. 

According to Azzahir, Maybank Investment Bank has invested over RM10 million to build up capability to manufacture these more complex structured products, while its team has grown to about 26 people today from about a dozen back then.

In recent years, equity-linked products and solutions have contributed over 50% of the total income of Maybank Investment Bank’s investment management pillar, which also includes the bank’s brokerage business and other ancillary products and services.

It should be noted that the bank’s equity capital market, debt capital market and merger and acquisition teams fall under another department known as investment banking advisory.

While Azzahir is proud of such an achievement and aims to grow the business further, he has not forgotten the various challenges he and the team faced in the past few years. Talent acquisition was the biggest challenge, as there were very few people who had experience in manufacturing structured products. Many of the team’s current members were trained on the job by senior members.

Azzahir and his team also invested heavily in building relationships with their clients and stakeholders to increase their awareness of structured products. “Today, I’m very confident to say that we are a leading equity-linked structured product issuer in Malaysia.”


Would banks trade against their clients’ interests?

During an interview with Wealth, Azzahir Azhar, head of investment management at Maybank Investment Bank, observes that some investors may wonder whether traders of a bank in charge of manufacturing structured products would trade against the interests of their clients.

Let us say a client invests in a minimum redemption investment (MRI) or SharkFin, whose performance is linked to Company X. While his principal is protected, he would forgo his returns when Company X’s share price exceeds 20% and receive a rebate at a much lower rate instead.

In this case, would the traders of the bank push up Company X’s share price when it rose by, say, 19.8%, to exceed 20%? The bank would then pay out much less to the investors. 

Azzahir says this is a common question among some investors. He assures that it is not in the interests of the bank’s equity commodity and derivative team to do so. 

“Let’s go back to why we are in this business. If our goal was simply to trade [to make a profit], we would have just set up a proprietary trading desk to do it. But the whole point of us being in this business [of issuing investment products] is to provide our clients with products and services for mutual benefit. And we have invested a huge amount of time and resources in building our infrastructure and relationship with our clients. Our aim is to fulfil their needs and demands.

“In offering those products, we will be exposed to market risks. So, we manage the risk exposure on our side to make those products accessible to our clients. Yes, we have a trading desk. But its responsibility is to understand the risks, price them and manage them properly. It trades solely for the purpose of risk management.”

Azzahir elaborates that on any given day, there would be clients who wish to invest in structured products to gain returns from the share price of a company going up or down, and the bank’s traders have to serve their needs. 

“There are clients coming to us to express a bullish view on Counter X. And within the same period, there are investors coming to us saying they have a bearish view on the same counter. This happens quite often.

“So, if all we want to do is to trade against clients, we can only handle one side of the book. If I’m bullish on Counter X, I’m not going to bet in the opposite direction. But the fact that we need to serve both sides shows that we are not here to trade off clients’ positions.

“For us to do well, we need our clients to do well first. If clients don’t, and have a bad experience losing money consistently, they won’t invest with us anymore. And there would be no reason for us to offer these products. Our interest is actually aligned to that of our clients,” he says. 


How your principal is protected and what to look out for 

Hann Liew, CEO of financial comparison website RinggitPlus, once worked with Barclay Capitals (now known as Barclays Investment Bank) to build structured products for its clients.

Liew says offerors of minimum redemption investment (MRI) structured products, or SharkFin, usually protect investors’ principal by pledging their money to a fixed deposit account of a bank, and use the interest returns to invest in derivatives that are highly leveraged.

“They take very high risk with your interest [returns]. Assuming that they place your money in a fixed deposit with a rate of 2.5% per annum, a two-year note would yield them 5% [of your initial investment amount]. They would, in general, use the money to trade option contracts,” he says.

However, how do they invest the interest returns of fixed deposits before they mature? An industry player says a bank would usually “pass” the fixed deposits to its treasury department, which has a team that manages interest rate risks. The team has the capability to pay out the interest rate returns in advance via a derivative instrument known as interest rate swap. 

“A part of the total sum would then be passed on to the derivative trading desk to ‘manufacture’ structured products,” he says.

Liew says the bank is able to manufacture these products and make a profit as they are charged only a thin spread to access various option contracts. “If investors were to do it by themselves, they get a wide spread.”

So, what should investors look out for when investing in structured products? 

An industry player says investors should not get overly excited about the relatively high coupon rates offered. They should, instead, focus on the downside and be prepared for the worst-case scenario. 

“An expert with lots of resources might be able to calculate the products’ historical and implied volatility before investing in them. But most people can’t do this. I would advise investors to understand the basics of how the products work, and what the worst-case scenario is.” 

Liew, who is also a licensed financial planner advising high-net-worth clients, says counterparty risk, which is the probability of the other party defaulting on the contractual obligations, such as when the product issuer goes bust, is a risk that is often underestimated by investors. 

“Counterparty risk is the number one risk that I will tell all investors about. By buying structured products, you’re not owning the asset. It is unlike investing in unit trust funds where the underlying securities are held by the trustee. So, if anything happens to the bank, if it goes bust, you have almost no recourse. The capital protection is only as good as the institution,” he says. 

While the scenario of a bank going belly up might seem far-fetched these days, it has happened time and again, cautions Liew. 

“That happened a lot in the 1997 to 1998 Asian Financial Crisis. Then there was the 2008 to 2009 Global Financial Crisis when institutional investors, including large pension funds, were holding [structured] notes that ended up going zero. I would say this is the biggest risk.”

He adds that investors need to really understand what they are getting into before buying structured products. 

“I would say these are quite exotic products. Even among high-net-worth investors, less than a handful of them understand the products. These are very specific products that give you very specific risks and returns. They bet on specific stocks and indexes. If you don’t understand them, don’t touch them. 

“If you are a high-net-worth looking for more exposure for better protection, there are many simpler ways to do it. If you think Malaysian equities are not exciting, look outside [the local market] first. You can simply diversify your investment overseas,” he says. 

Anthony Siau, founder and CEO of Kairos Capital Partners, which provides bespoke multi-family office investment services, says investors should understand the products well to invest in them. 

“Autocallables have an auto-call feature with pre-determined auto-call dates. Such products offer investors conditional soft protection with potentially higher coupons, which mean investors would need to have a view that the underlying securities will trend upwards over the tenure of the products. 

“As for SharkFin, investors would need to have a view that the movement of the underlying securities are at best positively range-bound.”

Siau, who was an investment banker, also advises investors to look at the underlying securities of the structured products, form their own views on the securities and compare them with the product structure. 

“If investors have a negative view on the underlying securities, and the product indicates an upward trajectory [of the price of the securities], don’t invest in them. 

“Financial institutions created such products not to lose money. So, when a structured product looks too good to be true, it usually is.” 

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