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'Boring' is the new black
AT THE start of the year, our Chief Investment Office (CIO) advised that 2019 would continue to see a highly volatile and non-trending market, following in the footsteps of a roller-coaster 2018. We're now almost at the halfway mark, and clearly this remains the case.
With event risks such as Brexit and US-China trade war tensions on the horizon, income investors increasingly need to factor geopolitical concerns and outlier events into their decision-making process, on top of the usual investment considerations around valuation and credit analysis. In addition, as the Federal Reserve and other central banks continue to keep interest rates lower-for-longer, we're seeing a rising hunt for yield amidst falling interest rates, narrowing credit spreads and an inverted yield curve environment.
Minimal upside in capital gains
The challenge is even greater for income-seeking SGD investors. Investment opportunities in the SGD bond market are rather limited, particularly in the investment grade space - to put things in perspective, there are currently around 350 actively quoted SGD bonds, of which only 64 are investment grade.
Yields are low, in the range of 2 to 3 per cent, given the amount of cash chasing a limited pool of assets. These bonds may also be hard to source since they do not trade on an exchange.
As a result, yield-seeking investors are at times driven to stretch for returns by investing in bonds issued by riskier issuers or buying bonds in higher-yielding currencies, which then incurs other risk dimensions such as foreign exchange risk.
We're also seeing growing interest for products such as fixed maturity funds, which are bond funds that buy into a diversified portfolio of bonds and have a pre-specified maturity that's usually four to five years.
These provide investors the assurance that they will be able to receive the full notional investment by the maturity date, barring any defaults in the portfolio.
In volatile times, 'boring' is where the money should be
Against this backdrop, our advice for income investors is that "boring" is where the money should be.
Going beyond stock and bond markets, there's a strong case for investors to explore the fact that structured products (a frequently misunderstood instrument often held as being too high-risk and complex) can be a good, stable and yes - boring - complement to existing portfolios.
Structured products may not be top-of-mind nor familiar to most investors, but there's much value they can deliver. Structured products are essentially investments which are linked to an underlying asset or basket of assets.
Designed to address specific risk-return objectives, they are highly customisable to investors' objectives and can be used as tools to help navigate certain market conditions.
In the current environment, income investors can explore structured products that are designed to achieve a stable income stream while reducing risks. One such example is the DBS Global Income Note, which has received a very positive response from our clients since we launched it in January this year - over S$1 billion was raised in just three months, and we're still seeing growing interest.
Fully conceptualised and managed in-house, the note was inspired by two things: the observation that clients' pent-up demand for well-diversified, stable income products outweighed the available options in the market, and the knowledge that we had the expertise to create a new product aimed at addressing these needs.
We structured a note linked to a portfolio of around 100 globally diversified and largely investment grade bonds, selected by our credit analysts and guided by our CIO's macro credit and duration views.
Actively rebalanced and monitored on an ongoing basis, the note provides investors with steady and regular income while enabling the benefits of diversification, which is essential in fixed income due to the asymmetric payoff profile - simply put, if you spend S$100 to buy a bond and it defaults, you have S$100 at risk whilst the return is limited to the coupon.
In contrast, if you buy a hundred different bonds, you could receive the same coupon but risk only a dollar on each default!
Structured products can also be designed to help investors tap investment trends in the market such as ESG (environmental, social and governance) investing, which seeks to achieve financial outperformance while also doing good. Still relatively nascent in Asia, many investors have yet to understand its benefits.
To this end, we were the first bank in Asia to introduce an outperformance structured product in August 2018, designed around the view that companies which operate in a sustainable fashion will, over time, do better than companies that do not.
The response was much better than expected, and we have since released five tranches of warrants and four tranches of notes.
Passive or risk-averse investors, do take note
There is a general conviction that interest rates are going to stay low for a while, with a dovish Fed that has reined in on its interest rate tightening course of action and other major central banks which are expected to ease monetary policies.
The increasingly volatile environment remains a concern, and it is essential for investors to keep close tabs on their portfolio - but this can be time-consuming and challenging, especially for passive investors who are less engaged in the day-to-day, or the risk-averse who crave more certainty.
As an alternative, investors can look to structured products that align with their investment objectives and can serve as a cornerstone of their investment portfolios, irrespective of recession or boom times.
- The writer is head of investment advisory and capital markets, DBS Wealth.