Examining the cost of investing
this article is from the business times
Charges embedded in structured deposits can be as much as 4% according to a JP Morgan report, says GENEVIEVE CUA
YOU have bought a structured deposit and were told that you would not be charged any fees. Can there really be no charges?
A report by JP Morgan examining the business potential of structured products spells out what you have long suspected: The charges embedded in such products are as much as 400 basis points, or 4 per cent, making them comparable to unit trusts.
That estimate is an average for what seems to be a fairly simple product which JP Morgan uses as an example. More complex or exotic products could raise the total spread to 500 basis points. The charges or spreads are deducted upfront, making them comparable to structured funds or unit trusts.
Fund managers with these products have felt the pinch from banks offering essentially the same structures. But fund managers are required to disclose annual management fees, which are usually deducted upfront. Investors in structured deposits, however, are always told there are no fees. That, arguably, creates an unequal playing field.
‘The total spread (400 basis points in the report’s example) may look high at first glance, but we would note that the spread is paid upfront, with no subsequent annual management fees. Comparing this to investing in a fund via a private bank, hedge fund or an asset manager where we would expect to pay 50 to 150 basis points of fees annually, we conclude that for the investor the cost of investing is quite similar.’
The report by analysts Kian Abouhossein and Jacob Kruse looks into the importance of derivatives to European banks’ profitability. There are gems to be gleaned for Asian markets.
For instance, the report says equity derivatives are in the midst of their ‘sweetspot’ between 2006 and 2008. Structured products are the most profitable business among equity derivatives, contributing well above 50 per cent of European banks’ revenues and two-thirds of profits. The biggest names in Europe are also familiar names here as the issuers of structured funds or warrants.
In JP Morgan’s review, the largest is Societe Generale, which includes its funds arm Lyxor; followed by BNP Paribas, Credit Suisse and Deutsche Bank. Any of these names will structure products for the retail clientele or on a wholesale basis for banks to sell to their clients.
Quoting AsiaMoney publication, the report says structured products’ volume growth in Asia is estimated at between 20 and 30 per cent a year since 2000. BNP Paribas, in a separate report, found that the total structured product volume in 2004 was US$90 billion in Europe; just below US$40 billion in Asia; and just over US$10 billion in the US.
The report uses a familiar product as an example – a structured product investing in a zero coupon and an over-the-counter option, giving the investor exposure to two stock indices. The product gives 100 per cent capital protection. The retail investor pays the face value of the note, that is, 100 per cent which is his capital. The seller of the note or product is typically a bank. The producer is an investment bank.
The distributor makes a gain from the outset on selling the note as the value and cost for the distributor is less than the 100 per cent the investor has paid. A zero coupon bond, for example, will cost 84 per cent, assuming a 3.53 per cent interest rate (using a five-year euro zero curve) and a five-year maturity.
The cost of an OTC option is estimated at 13 per cent. The option cost is key to the question of how much upside the investor could have, or how much ‘participation’ he gets in an index or basket of stocks.
This brings the total cost of the note to 97 per cent, and the bank keeps the remaining 3 per cent. [...]
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