Published October 23, 2009

Forks in the road for fund investors

Extreme market conditions are forcing hard choices on investors of some structured unit trusts

By GENEVIEVE CUA

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(SINGAPORE) Steep losses and sharp volatility in equity markets last year have caused a number of structured unit trusts to be 'knocked out' or monetised - some with virtually no hope of regaining market exposure.

'These funds have the objective of providing insurance against market corrections. They have served their purpose; they outperformed their peers.' - Tan Yong Sheng, Barclays Capital

However, most investors in the funds have chosen to stay invested, even if some of the funds are effectively invested only in zero-coupon or Singapore government bonds. This means the funds will pay no coupons or dividends.

Monetisation refers to an extreme event that forces the fund to be invested only in safe assets such as money-market funds or zero-coupon bonds. This occurs among a certain type of structured funds, to preserve capital. When this occurs, the funds typically cease to charge an annual management fee.

As far as The Business Times can ascertain, five different funds by Schroders and Barclays were affected in this manner. They were launched between 2004 and 2008. Some were marketed as income-yielding funds paying a coupon of up to 10 per cent a year. They have a combined value of over $320 million.

Said Tan Yong Sheng, Barclays Capital director of investor solutions: 'These funds have the objective of providing insurance against market corrections. They have served their purpose; they outperformed their peers.'

The affected Barclays funds are under the Celsius range: Bonus Select Income (SGD); Strategic Select Income (USD); and Global Commodities Dynamic Fund. The largest was the Bonus Select fund which has $252 million in assets.

Schroders' affected funds are the Accumulator and LiveSure 2025 funds. The Accumulator is the larger fund with assets of about $61 million.

Says a Schroders spokesman: 'The funds were targeted at risk-averse investors looking to participate in the growth of equity markets, while having a minimum floor that acts as a cushion when markets decline.'

Against the backdrop of an extremely difficult year last year, all the affected funds have fared reasonably well. Their net asset values (NAVs) are an oasis compared to the Minibond and structured notes disaster where investors lost all their capital. Barclays' Global Commodities Dynamic Fund, for instance, was monetised in October 2008 at an NAV of about 91 cents, at a time when the commodities market had plunged by some 50 per cent.

More recently, the Bonus Select Income Fund was monetised in September this year, with an NAV of 91.7 cents. Mr Tan says the fund outperformed its peers by 30 per cent since inception until September.

Schroders' Accumulator and LiveSure funds were monetised at $1.0622 and $1.0004 respectively.

The funds have a similar strategy, basically a form of portfolio insurance known as 'constant proportion portfolio insurance' (CPPI). This is also at times referred to as a 'dynamic' strategy. The fund will allocate assets to a 'safe' or conservative basket and to a risk basket usually linked to equities. The allocation is typically done in a mechanised way to preserve capital.

As the market rises, the strategy allocates more to the risk basket. It pares down its allocation in a falling market. The prospectuses describe a number of scenarios, one of which is that which has transpired - that the market has gapped down so much that the assets are fully allocated into the cash or bond portion. When this occurs the fund is typically not able to regain its risk exposure, even if equity markets recover.

There were a number of CPPI funds launched with capital protection around 2001. Some of those managed by SG Asset Management, for instance, were monetised at around 92 cents, as they were hit hard by the sharp fall in markets following the 9/11 terrorist attack, which occurred shortly after their launches. Investors were disappointed that the funds were unable to participate in the market rally that ensued after 2002.

Schroders, however, will begin to reinvest the Accumulator fund. In a recent extraordinary general meeting, investors voted to restart the investment strategy from Nov 24. 'The Accumulator will start investing into growth assets again with a new minimum floor, with an enhanced strategy that aims to reduce the risk of monetisation.'

The Accumulator's NAV will be determined on that date based on the value of its assets. It will be invested in a portfolio of multi-asset funds, and it will charge an annual management fee of one per cent.

Barclays has written to investors to explain their options. Mr Tan says there are three choices. One is to stay invested in the funds which will be effectively zero-coupon bonds, and wait till the capital is made whole at a specified date. For the Bonus Select Income Fund, for instance, the fund will reach an NAV of $1 in 2013. From that point, the $1 NAV will be guaranteed by Barclays Bank.

A second option, he says, is to buy more units. The annualised yield-to-maturity at the current price is about 2.4 per cent. The yield beats current deposit rates.

A third option is to cash out. About 20 per cent of investors have done so. 'If you believe equity markets are bullish now that the product has provided insurance, you can switch out.'

After 2013, the fund's assets will be invested in money-market funds. Once it reaches a certain threshold, it will begin to reinvest in markets.

For investors, it will therefore depend on their objectives, risk appetite and opportunity costs. Deposit rates are meagre compared to the quoted yield-to-maturity, but at the same time, equity markets - particularly in the emerging markets - are seen to be on an uptrend in the near term, buoyed by low interest rates and ample liquidity.

There is no plan for now to reinvest Schroders' LiveSure Fund. In a letter to investors, the firm has explained the options. One is to stay invested at the NAV of $1.0004.

It also says, however, that the objective of achieving the 'target protection price' at maturity is not guaranteed and is subject to risks. 'The Manager will aim to meet the investment objective of the fund on a best efforts basis only.'

A second option is to switch to another Schroders fund for free. Or, investors could simply cash out.