Currency Diversification - Five Ways to Hedge Against Ringgit Volatility

The rising affluence of Malaysians and the ringgit’s gyrations have forced people to look into ways to hedge against the US dollar

A RETIREE who loves to travel posed this question during a property launch of a project in London recently that struck a chord.

It was just after the Employees Provident Fund had declared a 6.75% dividend to contributors for 2014. It was the best-ever performance since 1999, but to the pensioner, he actually felt poorer.

“What is the point of a 6.75% return when the ringgit has depreciated from RM3.10 against the US dollar to almost RM3.70? It is a decline of almost 20%,” he posed.

Over the past seven months, the ringgit has moved from as high as RM2.99 per dollar to a low of RM3.70 per dollar. The weakening ringgit against the US dollar has, no doubt, rattled investors, especially those with the need for foreign currencies.

Whether it’s a parent looking to fund his or her child’s education overseas, or to pay off the mortgage for a property, the movements in the ringgit have put many on the spot.

The ringgit’s steep decline against the greenback started last September, shedding 10.8% to end at 3.495 against the US dollar as at end-2014.

The fall in commodity prices didn’t help either – which also contributed to the ringgit hitting a six-year low of 3.7350 against the dollar on March 20.

Uncertain times for local currency

Until mid-2005, the ringgit was pegged at RM3.80 against the US dollar. Only after the US Federal Reserve launched the first round of quantitative easing at the beginning of the global financial crisis in 2008 did the ringgit start to depreciate.

The gyrations bring back memories of the 1997/98 Asian Financial Crisis, where many were caught – be it parents or investors – off guard. At that time, the ringgit against the pound sterling was almost at RM7.

Against the US dollar, it went from RM2.50 to more than RM4 within a year from July 1997. Prior to 1998, when the ringgit was still an international legal tender, Malaysians could easily hedge the exposure. However, after Sept 2, 1998, when capital controls were imposed, the movement of the ringgit was restricted.

Only some time in 2007 after Bank Negara relaxed the restrictions that local banks started offering some hedging mechanisms.

However, actual hedging was not really required until the last one year. Thanks to rising affluence, today, more are purchasing property or educating their children overseas.

According to HSBC’s “The Value of Education” survey for 2014, Australia is the most expensive destination for overseas students. The average international student, reports the bank, would need US$42,093 (RM151,000) a year to cover both tuition fees and the cost of living in Australia.

Following Australia in the cost table are Singapore (US$39,229), the United States (US$36,564), the United Kingdom (US$35,045) and Hong Kong (US$32,140).

Taking these factors into account, it’s not surprising to see investors looking for safer, alternative investments that can help them hedge against the volatility of the ringgit. Below are four – or rather five – options for the normal and high-net-worth individuals to ponder over.

Property

Investing in property overseas is seen as one way to hedge against the ringgit’s volatility.

Knight Frank Malaysia managing director Sarkunan Subramaniam says it would not be surprising to see more individuals investing in properties overseas looking to hedge against the weakening ringgit.

“One way to hedge against a weaker ringgit before it falls is to buy properties in countries where the currency is more stable against the US dollar.”

When it comes to property, Sarkunan says most investors’ preferred investment destinations are usually the US, the UK and Australia.

“It’s an indirect way of hedging.”

Sarkunan says there is no financial criteria when investing in property overseas.

“As long as you have the money, you can.” However, he adds that investing in properties overseas does have its risks.

“At the end of the day, you’re still exposed to a currency, so you can go wrong too.”

OCBC Bank (M) Bhd vice-president for research wealth management, Michael Lai, says investment in a property overseas helps to diversify an investor’s assets from a ringgit base to the foreign currency base of the property in question.

“For example, a Singapore property investment would mean the investor has diversified into the Singapore dollar. Diversification reduces the volatility inherent in holding one’s wealth in a single currency.”

He says investors who qualify as high net-worth individuals are free to make investments in foreign assets under Bank Negara’s guidelines.

A developer says that the best foreign property bets are in countries that have depreciated the most against the US dollar because of uncertainties in the domestic scenario.

“This is because it stands to gain the most if the uncertainties clear up. A 5% appreciation against the dollar and another 20% appreciation in the property price over two years will be a good return,” says the developer.

On the local front, Agency of PPC International Sdn Bhd CEO Siva Shanker believes that the local property market is a safe sector for investors to park their money in.

“It is arguably the best hedge against inflation. The appreciation of property prices outweighs inflation,” he says.

‘The appreciation of property prices outweighs inflation’. Today, property prices are so high. However, rentals have not caught up, so returns are not as high – maybe between 3% and 4%. On top of that, you still have borrowings to take care of.” he says.

Siva notes that investors within the property sector can achieve double-digit capital appreciation growth annually over the longer term.

“Generally, capital appreciation within the property sector can range between 5% and 15% per year. In a good year, it could go up to between 20% and 25%. In a bad year, maybe just 5%.

“However, it still goes up, no matter what.” He says that the level of property transactions has been dropping since 2012.

“In 2013, it dropped by around 10.9%. I am projecting that it was probably flat last year. Since 2012, prices have never gone down but transactions have.

“Yes, there may be corrections, but in totality, it goes up. It’s still better than putting money in the bank.”

Dual currency deposits

Local banks have started to offer dual currency deposits in a big way, especially now with the weakening of the ringgit.

According to Citibank Bhd retail banking head Rakesh Kaul, these are structured investment products that are linked to a foreign exchange option, whereby investors have the flexibility to choose their preferred currency pairs, as well as tenures that suit their needs and goals.

“Available tenures range between one week, two weeks and one month,” he says, adding that Citibank offers dual currency deposit contracts in nine currencies.

“Before investing, an investor will have to agree on the strike price for the currency pairs and tenure selected. The strike price is the pre-determined exchange rate which an investor has selected at the point of subscription.

“The prevailing exchange rate upon expiry of the contract is compared to the strike price and determines whether the final payout will be paid in the base currency or alternate currency,” says Rakesh.

He adds that dual currency deposits are suitable for those who need diversification to foreign currencies and are indifferent to holding the currencies selected.

“Investors who are willing to and are able to take foreign exchange conversion risks would look into dual currency deposits as an investment tool, as it allows an investor to potentially earn a higher interest rate compared to a conventional time deposit.

“Alternatively, an investor who may just want to do a currency exchange at the pre-determined strike price would look into dual currency deposits as well.”

According to data by Bank Negara, foreign currency deposits by individuals in the banking system surged more than 400% to RM12.68bil as at end-2014 from RM2.46bil in 2007.

Success Concepts CEO and licensed financial planner Joyce Chuah cautions that dual currency deposits are suitable for those who fully understand how the concept works - and prefer higher returns by trading rather than investing into global stocks or funds.

“Understand carefully in what situations your dual currency account might not yield you any returns. Also, take the time to understand the risks involved.”

Some do not even recommend investing in dual currency accounts to hedge againt the ringgit volatility.

MyFP Services Sdn Bhd managing director Robert Foo is one of them and feels it is the wrong thing to do.

“Here, you’re relying on another currency that could just as well appreciate at any time. How would you know if that (foreign) currency is going up?”

One thing is for sure. The dual currency deposits are more useful for people who need foreign currency for whatever reasons such as to pay the tuition fees for their children abroad or instalments for a property. It is not meant for speculating because the investors should be prepared to hold on to the foreign currency.

Offshore investing

Foo believes that a wiser, better option would be to look into a diversified portfolio of investments overseas.

“This could be in funds, bank accounts, property, exchange traded funds or stocks.”

“Diversify your currency exposure in other asset classes where the currency is different. What you invest in will depend on your financial needs, goals and risk appetite.”

Unlike dual currency deposits, which focus on a single currency, Foo feels that one should invest in an instrument that invests in multiple currencies.

“It’s like placing your money in a local fund that invests in a number of stocks. Here, you invest in several foreign currencies.”

Here, a potential investor has the choice of either placing their money with a wealth manager or in foreign stocks and bonds.

Chuah says investing in global stocks and bonds is suitable for those who have the skill and time to manage (the stocks and bonds) and can “take the vagaries” that come with these investments.

“It’s a good hedge because they provide capital returns (unlike low deposit interests) as well as foreign exchange returns, assuming the currency in question appreciates against the home country’s currency.”

A wealth manager comes in when a person doesn’t have the requisite expertise to manage the investments. Such is the case for global funds, says Chuah.

“These are suitable for those who have no time or skill to manage investments into direct global stocks. It provides a diversification into a basket of currencies via their stock investments, which are usually spread across various countries.”

An industry observer notes that Singapore is a preferred investment destination for many investors because there are banks there that offer investments in a wide range of assets.

“For instance, an investor has the option of buying into bonds of emerging markets as well as developed economies. It can be in US dollars, the euro or any other currencies. The options are wide,” says the investor.

Foo concurs, pointing out that Malaysia is still a closed market when it comes to investment options.

“There are certain funds that are not allowed to come in,” he says.

Another industry observer notes that upfront fees for investing in unit trusts in Malaysia are also higher compared with other countries such as Singapore or even Thailand.

According to reports, upfront unit trust fees in Malaysia can go up to 6%, while that in Singapore can go up to 5%. Thailand, meanwhile, has lower upfront fees of up to 2%.

Foo says that offshore investing is generally catered to high-net-worth individuals.

“It’s ideal for those who can spend and invest more, if you want to get better returns,” he says.

And like any type of investment, placing your money overseas will have its downsides too, Foo adds.

“At the end of the day, it depends on the individual’s risk appetite.”

Stocks that benefit from the ringgit volatility

Another way to mitigate the ringgit volatility is to invest in stocks that can benefit from a higher US dollar, or even low commodity prices.

“These would include companies whose exports have high local ringgit-denominated content and robust external demand,” says an analyst from a local bank-backed brokerage.

He says the rubber, semiconductor and technology, as well as timber-based sectors, are more resilient in times when the ringgit is weak. He cited the World Semiconductor Trade Statistics, which revealed that global semiconductor sales are expected to remain stable.

Based on the latest forecast, sales are expected to reach 3.4% and 3.1% for 2015 and 2016, respectively, from an estimated 9% growth for 2014, he says.

“The good growth is mainly due to higher demand from the automotive and telecommunications sectors,” he says.

Another analyst concurs that rubber product manufacturers such as Top Glove Corp Bhd, Supermax Corp Bhd and even condom manufacturer Karex Bhd are beneficiaries of the weaker ringgit.

“In the rubber glove segment, this is generally because their US dollar-denominated income will translate into better earnings once it’s converted into the ringgit.”

Other segments are industries such as furniture producers such as Latitude Tree Holdings Bhd and poultry producers that have gained from the currency volatility. The furniture makers gain because their sales are in US dollars, while the poultry players benefit from cheaper raw materials due to the depressed prices of feed stock such as corn that have come down due to the stronger dollar.

Fifth option

The fifth option for those without any urgent need to diversify their ringgit holdings but requiring small amounts of foreign currency from time to time for probably their holiday travels, the safest option would be to physically hold the foreign currency of their choice and purchase them whenever the currency depreciates. However, this is less practical and safety is an issue.

“It’s easy to purchase the currency of their choice. But not so practical as storing them safely can be an issue. Plus if one is not buying in large quantities, then the cost of acquiring them can be a downside factor.”

“If you intend to buy and sell the physical currency for currency gains, do be mindful of the spread (transaction costs) involved by exchanging them at the foreign exchange.”

Source - thestar.com.my

Below were the performance of Ringgit Malaysia against major currencies of the world.

Diversification - Currency Diversification

So what is currency diversification and should you add currencies into your Mix?

It is a portfolio diversification strategy in which securities are purchased in various foreign currency denominations for purposes of minimizing foreign exchange risk, increasing global exposure, and capitalizing on exchange rate disparities. The currency fluctuation and volatility has prompted many to study the need to diversity your asset class into various currencies denomination. 

The need of currency diversification has been accelerated by events happened in the past as well as what is happening now. 

Take a look at the 2008 financial crisis that hard hit many countries around the world when all sorts of assets fell in tandem, supposedly revealing that the benefits of diversification are ephemeral. A quick look at the core stock classes in 2008 shows that pain was evenly spread across every major category with U.S. stocks down 36.2 percent, foreign developed markets down 43.4 percent, emerging market stocks 52.9 percent, and even the nontraditional classes of REITS and commodities hit with declines of 37.6 percent and 31.9 percent respectively. And what is happening now is the phenomenon of globalization has further drive the need for currency diversification for the need of international trade settlement.

Many investment experts now advocate and suggest that currencies as the new answer for a truly diversified portfolio. 

Currency can play an important role in the overall results delivered by a diversified portfolio. The benefits of holding foreign currency exposures can be summarized  as follows: 

• Foreign currency offers strong diversification benefits, reducing risk.
• Interest rate differentials of foreign currency denominated exposures can generate an additional layer of returns, called 'carry' trade.

For diversification, let's look at below chart. As demonstrated by the below chart, adding developed market foreign currency reduced the total fund risk. Interestingly, the impact of adding emerging market foreign currencies is only marginally less pronounced. Indeed for a reasonably large exposure there is a reduction in volatility.

Source: Perpetual, Bloomberg. Both live and back tested data has been used for the Diversified Real Return Fund. Results are for 31/12/1987 to 30/06/2013. Developed and emerging market currency baskets approximate the foreign currency exposures of the MSCI World ex Australia and MSCI Emerging Markets.

For 'Carry' return, it is a strategy in which an investor sells or borrows a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture the difference between the rates, which can often be substantial, depending on the amount of leverage used.

As demonstrated by the below chart Australia has generally had higher interest rates relative to much of the developed world. This means that generally the carry for holding developed market foreign currencies would detract from performance. This is in contrast to many emerging markets, which have higher interest rates. Holding these currencies would have an improved impact on returns.

Source: Perpetual, Bloomberg. Emerging market currency basket contains Korean won, Malaysian ringgit, South African rand, Russian ruble, Polish zloty, Brazilian real, Mexican peso.

Now take a look at below graph, it will give you a very convincing reason why you should adopt currency diversification in your portfolio if the administration and financial management of your country are in a total mess. 

A strong, well administrate and managed with good governance country will be reflected by their currency value in international forex market.

Well, if I had RM10,000 in 1965 and kept in the bank of Singapore and assuming a risk-free average deposit rate of 3% per annum in this entire 50 years period, my savings would have grown to SGD43,839 and if I convert it back to RM now, the value after conversion would be a whooping RM119,680 with an average rate of return of 5.09% per annum. No bad at all for a risk-free investment.

Diversification - Findings and Facts

The gist of diversification is strive to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.

Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25 to 30 stocks like unit trust funds will yield the most cost-effective level of risk reduction. Investing in more securities will still yield further diversification benefits, albeit at a drastically smaller rate.

Further diversification benefits can be gained by investing in foreign securities because they tend be less closely correlated with domestic investments. For example, an economic downturn in the U.S. economy may not affect Japan's economy in the same way; therefore, having Japanese investments would allow an investor to have a small cushion of protection against losses due to an American economic downturn.

Since the mid-1970s, it has also been argued that geographic diversification would generate superior risk-adjusted returns for large institutional investors by reducing overall portfolio risk while capturing some of the higher rates of return offered by the emerging markets of Asia and Latin America.

Most non-institutional investors have a limited investment budget, and may find it difficult to create an adequately diversified portfolio. This fact alone can explain why mutual funds have been increasing in popularity and make headway to offer offshore funds where money will be invested in regional share markets. Hence buying shares in a mutual fund can provide investors with an inexpensive source of diversification.

The Hype of Diversification

The term of "Diversification" in finance and investment is closely related diversification of money into different and various asset class to minimize the risks of investment or simply put it as asset allocation of various asset classes namely stocks, bonds, unit trust, real estates, commodities and etc. However, one of the investment diversification that is rarely capture our attention is "Currency Diversification".

Recent critics of asset allocation, however, have pointed out that due to factors such as globalization, many assets including stocks now move in lock step. This trend, they say, is illustrated in the 2008 crash when all sorts of assets fell in tandem, supposedly revealing that the benefits of diversification are ephemeral.

A quick look at the core stock classes in 2008 shows that pain was evenly spread across every major category with U.S. stocks down 36.2 percent, foreign developed markets down 43.4 percent, emerging market stocks 52.9 percent, and even the nontraditional classes of REITS and commodities hit with declines of 37.6 percent and 31.9 percent respectively.

Where is the non-correlation in this asset allocation? These facts, the critics point out, prove that the asset allocation models of the past are now bunk and in need of a desperate overhaul. 2008 is said to have sounded the death knell for all of modern finance. In response, one idea that has gained traction among some managers is the notion of adding global currencies as a new type of uncorrelated asset class.

Globalization has created many reasons for increasing the diversification of an investment portfolio outside of the home country, particularly in terms of diversifying currency, that are crucial for investors to consider now. 

Next we see what is currency diversification and why should you add currencies into your Mix?

Diversification of Investment - Concept

Definition of 'Diversification'

1. In Corporate's term

Diversification is a corporate strategy to enter into a new market or industry which the business is not currently in, whilst also creating a new product for that new market.

2. In Finance and Investment's term

Diversification is a risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

3. In Layman's term

Diversification is to distribute (investments) among different companies or securities in order to limit losses in the event of a fall in a particular market or industry. In the most general sense, it can be summed up with this phrase: "Don't put all of your eggs in one basket."

What is Diversification?

Taking a closer look at the concept of diversification, the idea is to create a portfolio that includes multiple investments in order to reduce risk. Consider, for example, an investment that consists of only stock issued by a single company. If that company's stock suffers a serious downturn, your portfolio will sustain the full brunt of the decline. By splitting your investment between the stocks from two different companies, you can reduce the potential risk to your portfolio.

Another way to reduce the risk in your portfolio is to include bonds and cash. Because cash is generally used as a short-term reserve, most investors develop an asset allocation strategy for their portfolios based primarily on the use of stocks and bonds. 

It is never a bad idea to keep a portion of your invested assets in cash or short-term money-market securities. Cash can be used in case of an emergency, and short-term money-market securities can be liquidated instantly in case an investment opportunity arises, or in the event your usual cash requirements spike and you need to sell investments to make payments. 

Also, keep in mind that asset allocation and diversification are closely linked concepts; a diversified portfolio is created through the process of asset allocation. When creating a portfolio that contains both stocks and bonds, aggressive investors may lean towards a mix of 80% stocks and 20% bonds, while conservative investors may prefer a 20% stocks to 80% bonds mix.

Regardless of whether you are aggressive or conservative, the use of asset allocation to reduce risk through the selection of a balance of stocks and bonds for your portfolio is a more detailed description of how a diversified portfolio is created rather than the simplistic eggs in one basket concept. 

With this in mind, you will notice that mutual fund portfolios composed of a mix, which includes both stocks and bonds, are referred to as "balanced" portfolios. The specific balance of stocks and bonds in a given portfolio is designed to create a specific risk-reward ratio that offers the opportunity to achieve a certain rate of return on your investment in exchange for your willingness to accept a certain amount of risk. 

In general, the more risk you are willing to take, the greater the potential return on your investment. As such, adopt an investment diversification plays an important role to minimize risk and maximize return in your investment plan and strategy.    

Structured Investment - Guide and Information You Should Know

The Structured Investment segment always considered as one in which retail investors have more alternative ways to diversify into the investment products, in terms of preferred assets class and the variety of combinations of returns available. 

However in investment markets we heard many comments such as “they are ideal and very attractive now to capitalize the high volatility of markets”, “investment plans look less attractive when markets are on the very high-side now”, “markets have hit bottom and time to accumulate” are consistently thrown around by many familiar with investment markets. 

But, in truth, the flexibility afforded by these new alternative investments world means that they can be structured or designed to suit not only many different individual profile with differ risk appetites but also many different investment market cycles and climates of the current investment trend. 

Over the last two decades or so, and on top of the usual equity highs and lows, the investment markets have had to swallow some contagion financial crisis such as the Asian Financial crisis, the fall-out from Lehman Brothers, the credit and liquidity crisis, the banking crisis, recession, fear of a double dip recession and now the continuing Eurozone debacle, the fear of falling oil prices, IS and unrest in middle east countries. 

The timely introduction of structured investment products are ideal for defining risk, return, exit, and direct entry into the investment markets, may be attractive to capitalize and take advantage the current investment scenarios.

Below are some salient features of structured product and what you should know and how does it influence the product.  

1. Capital Protection

A fixed level of protection regardless of the performance of the underlying asset.

What you should know - Apart from the counter party risk, this is as near to full capital guaranteed protection as you can get. However, it is not always 100% and needs to be checked. Generally, a lower capital protection level and higher participation rate will give you a higher potential return on investment, and vice versa.

2. Soft Protection

Protection of the initial capital is dependent on the performance of the underlying asset. The protection level may reduce or even disappear if the underlying asset breaches a certain level on the downside. Where this floor is set affects the cost of the product and therefore will affect the participation levels.

What you should know - Whether capital or soft protection is chosen and at what level, is dependent on the risk profile of the client and their confidence in the markets. Where there is more than one underlying asset or index, terms need to be examined closely to determine how many of the assets need to breach the levels set before downside protection is affected.

3. The Capital Protection Level

This is the percentage of your investment that you are guaranteed to get back when your structured product reaches maturity. You can set this level up to 100% (guaranteeing that you get back your investment in full).

What you should know - By lowering the capital protection level to 90%, for example, you will be putting 10% of your money at risk, but your potential return on investment will increase significantly.

4. Participation Rate

The return at maturity is based on the performance of the underlying asset, but is often geared to return a fixed percentage of the performance of the underlying assets at, greater or less than 100%.

What you should know - Usually the higher the participation rate, the less the level of protection and/or a lower capped maximum.

5. Product Maturity

Product maturity refers to when a structured product will expire. 

What you should know - The maturity date of structured investments is pre-determined. It can be days, months or as long as 10 years. A product with a "Product Maturity" of 60 days, for example, will expire in 60 days. A product's return on investment is determined on the date it reaches maturity. The earnings from the product will be returned to the investor's transitory account.

Source: alpari.com, "What is "product maturity"?"

6. Lock-up Period

The pre-determined time frame in which investors of a structured investments are not allowed to redeem or sell. The lock-up period helps portfolio managers avoid liquidity problems while capital is put to work in sometimes illiquid investments.

What you should know - Some investments require up to a two-year "lock-up" commitment, but the most common lock-up is limited to one year. In some cases, it could be a hard lock, preventing the investor from withdrawing funds for the full time period, while in other cases, an investor can withdraw funds before the expiration of the lock-up period provided they pay a penalty. This second form of lock-up is called a soft lock and the penalty can range from 2-10% in some extreme cases.

7. Kick-Out

If the original target return or a predetermined level is reached early (usually at a specified point during the term), the plan will mature early.

What you should know - Usually this is a good thing for investors.

More information on structured investments in Malaysia

1. Banking Info - Structured Investments

Introduction To Structured Investment

Structured Investment

The word “structure” defines by Free Dictionary as “something made up of a number of parts that are held or put together in a particular way” or “the way in which parts are arranged or put together to form a whole”. 

In relate the word “structure” to investment term then it simply means as an investment product that is a pre-packaged investment strategy based on derivatives. Derivatives is defines as a contract that derives its value from the performance of an underlying entity or combination of few entities.

The underlying entity can be an asset like gold, silver, commodities or index of share market, gold future, option, or interest rate futures and options, a single security or a basket of securities, debt issuance and/or forex in single currency or multi-currencies. Hence, the structure product is also known as a market-linked investment based on these entities.

A typical feature of some investment structured products is a "capital guarantee" function, which offers protection of principal if held to maturity. For example, an investor invests $1,000 in a 5-year capital-guarantee product and the issuer may just simply invests in a risk-free bond that has sufficient interest to grow to $1,000 after the five-year period. This bond might cost $800 today and after five years it will grow to $1,000. This would give a protection of capital for the 5-year investment plan. With the leftover funds of $200 the issuer purchases the options and futures needed to perform whatever the investment strategy.

As such, structured investments were designed to meet specific needs that cannot be met from the standardized financial instruments available in the markets. Structured investment can be used as an alternative to a direct investment, as part of the asset allocation process to reduce risk exposure of a portfolio, or to utilize and capitalize the current market trend.

How structured investments work?When you buy a structured investment, you also agree to tie up your money for a pre-determined period. Some of these products offer you a lump sum at maturity depending on the performance of the underlying entities.

Examples of structured investments:

"If the Bursa Malaysia is higher at the end of the five years than it was at the beginning, you get your original investment back plus an extra 30% - a total of $1,300.

If the Bursa Malaysia is at the same level or lower than it was at the beginning, but is less than 50% lower, you get your original investment of $1,000 back but nothing extra.

If the Bursa Malaysia has fallen by 50% or more, the amount of your original investment you get back is cut by the same percentage – so if the Bursa Malaysia has fallen by 60%, you’d only get 40% of your money back, a total of $400.

Other structured investments let you take a regular income and whether or not you get back your original investment in full depends on how the stock market index or other measure has performed. If the stock market falls, you can lose a very large chunk of your original investment.

Risk of structured investments

Structured investments are commonly offered by insurance companies, banks and private fund managers. Your money typically buys two underlying investments, one to protect your capital and another to provide the bonus. The return you get depends on how the stock market index or other measure performs. In addition, if it performs badly or the firms providing the underlying investments fail, you may lose some or all of your original investment.

The risks associated with many structured products, especially those that present risks of loss of principal due to market movements, are similar to risks involved with options. The serious risks in options trading are well-established and customers must be explicitly approved for options trading. The Securities Commission Malaysia (SC) suggests that firms "consider" whether purchasers of some or all structured products should be required to go through a similar approval process, so that only accounts approved for options trading would also be approved for some or all structured products.

"Principal-protected" products are not always insured by the Perbadanan Insurans Deposit Malaysia (PIDM) in Malaysia and thus could potentially lose the principal if there is a liquidity crisis or bankruptcy. Some firms attempted to create a new market for structured products that are no longer trading; some have traded in secondary markets for as low as pennies on the dollar.

If you take out a structured investment with, say, a bank or insurance company it’s not usually that firm which promises to return your original investment or to pay a given return on your money.

Instead the bank or insurance company will buy some complex underlying investments from one or more other companies, often referred to as ‘counterparties’.

Because you don’t have any agreement yourself with the counterparties, if any of them fails – so that your structured investment fails to give you your money back or provide the promised return – you don’t have any direct claim on the counterparty and no compensation scheme would apply.

Instead, you would have to try to seek redress from the bank or insurance company that sold you the product or any adviser who advised you to take it out. You would have to show that the bank, insurance company or adviser had not made the risk of the counterparty failing clear to you.

In addition, banks selling structured products often talk about ‘capital protection’ – but this doesn’t necessarily mean that your money’s completely safe. There are two common types of protection:

Full protection – also described as ‘100% capital protection’, ‘capital security’ or a ‘capital guarantee’, this means that the minimum that you receive on maturity should be at least equal to the amount originally invested.

Partial protection – how much of your original money you get back depends on the performance of the index your product is based on and only a proportion – say 90% - is protected by the capital ‘guarantee’.

In either case, there is still potential for capital loss as described above, if the company providing the guarantee runs into trouble.

Information you should be given for structured products

Structured investment product providers must provide you with ‘key facts’ information that you can understand, covering:

1. What the investment is and how it works

2. The key risks including the risk of capital loss and counterparty risks

3. Charges (the fees that will be deducted from your returns or capital)