SIPS Mods

On the last few days of 2019 & into Jan 2020, I had to clear a mod from this e-learning portal on Specified Investment Products (SIPs). It was mandatory to do so to start a live account for trading on IG trading (which I have not come around to do). I decided to take advantage of the free platform & made notes on all the mods I could in a span of 3 to 4 days. The SIPS mods are jointly developed by The Association of Banks in Singapore (ABS) and Securities Association of Singapore (SAS). The free portal URL: https://sips.abs.org.sg

Contents:

ILPS

Unit Trusts

Structured Products

Structured Deposits

ILPs

Intro to ILPs

Life insurance policy providing both protection and investment. Invest in an ILP sub-fund. No guaranteed cash value

Single Premium ILP

Premium payable in one lump sum

Regular Premium ILP

Premium is on-going on a periodic basis. Front-end loaded RPILP have lower unit allocation rates during initial policy years, and higher allocation rates during later years. Back-end loaded RPILP have either very low or high sum assured (SA)

Benefits

Flexibility: Most front-end RPILP have flexibility to vary SA, premiums and investment allocation. Clients can exercise premium holiday option where they stop paying premiums temporarily in times of financial difficulty (coverage maintains, charges can be deducted from accumulated NAV)

Choice of Funds: Choose from wide range of funds & switch funds when needed (check if any charges apply)

Low Capital Outlay: ILPs operate like unit trusts in terms of pooling. RPILP also allows you to take advantage of dollar cost averaging concept, regardless of market conditions (Dollar cost averaging: strategy of investing equal amounts regularly & periodically over specific time periods. Thus more units of ILP sub-fund are purchased when prices are low & fewer are purchased when prices are high)

Diversification: Different asset classes

Transparency: Traditional life insurance policy value depends on the performance of participating funds. As for ILPs, policy value is derived from underlying funds.

Riders: Enhance coverage at additional cost

Risks

Investment Returns: Not guaranteed

Charges: Not guaranteed. RPILP charges may be adjusted by insurers. Increase in charges would only arise if there was a sustained worsening of claim experience

Units May Be Insufficient: Charges may not be covered by units in funds

Unit Trusts

Intro to Unit Trusts

Pool of money combined from other investors, managed collectively by a fund manager. Professional fund managers then invest in a portfolio of assets on your behalf. Unit trust investments can include a single asset class, or a range of asset classes such as equities, fixed income, property, money market instruments. Can also be invested in specific geographical markets, sectors and styles (e.g. value, growth, small capitalisation stocks)

Number of units received in investment = (invested amount - sales charge) / prevailing net asset value of underlying asset

Net asset value = fund asset - liabilities

Every unit sold to the public must’ve accompanied by legal documents called prospectus and product highlights sheet (contains important info like the fund’s objective, strategy, risks, fees, historical performance etc)

Benefits

Suitable for those who seek diversification

Professional Management: Actively monitor investments based on research and analytical tools that you may not have access to, with their expertise and experience, on your behalf

Lower Capital Outlay & Diversification: By pooling your money with others, the funds can be invested in a wider range of assets. Assets like bonds require a min. investment of $100,000 which may be difficult for individuals alone, whereas they could gain exposure to a basket of bonds for $1,000 capital outlay. Pooling also diversifies investments, thus spreading risk

Economies of Scale: Fund management companies enjoy EoS when they purchase securities due to volume and size of trades. Savings are passed back into unit trust

Liquidity: Unit trusts are valued every business day and allows investors to redeem units and access money easily

Flexibility when Risk Appetite Changes: When investor’s risk appetite changes, he can rebalance his portfolios by switching from one fund to another within the range/umbrella of funds (‘intra fund house switch") at a reduced cost due to range of unit trusts available

Accessibility: Certain markets or instruments which investors alone cannot access to. E.g. specific geographical regions that cannot be accessed

Risks

No Control Over Individual Investments: All decisions are made by fund manager

Limits to Diversification: Most funds tend to focus on investing in asset classes and segments of markets that fit their objectives. They may thus be limited from straying too far from their investment mandates

Sales Charges: Usually up to 5%. Best to spread such costs over the long term

Management Fees: These fees are charged regardless of performance. In the long run, these would affect returns, thus compare fees across funds

Performance of Fund Managers: If managers with superior performance leave funds, the unit trusts may not continue to perform as well as before. Take note of then banks notify about changes in management

Market Risk: Prices of securities can fluctuate in response to the activities of companies and sectors, general market or economic conditions

Interest rate Risk: Generally, bond prices move opposite to i/r

Credit Risk: Value of unit trust may fall if issuer of underlying bond is unable/unwilling to make timely principal and/or interest payments

Country Risk: Prices are also affected by political and economic condition of the country

Currency Risk / Forex Risk: Currencies can move unfavourably against the currency in which the unit trust in denominated in

Fund Management Risk: Poor management jeopardises performance

Factors to Consider

Investment Goals: E.g. provide income, capital growth, retirement, children’s education

Risk Profile: Determined by risk appetite. Depends on age, financial situation, investment objectives

Liquidity Requirements: Ensure sufficient liquidity to meet spending needs. Consider unit trusts with daily dealing frequency as they can be easily liquidated

Time Horizon: Time period in which to stay invested. Linked to goals and age. Affects type of investment included in portfolio e.g. more bonds if shorter time horizon for lower risk

Risks

Fund Manager / Investment Team: Be comfortable with their experience & skills to manage investments

Monitoring Performance: Check price of unit trust on website of distributor, website or fund provider, Straits Times or Business Times etc.

Common Unit Trusts In Singapore

Equity Funds: Invests primarily in stocks. Meant for investors with higher risk tolerance due to volatility. E.g. global equity funds, regional equity funds, single country funds, single sector funds. Global equities are lower risk than sector funds as sector funds are more focused and thus more concentrated in a particular investment, leading to higher risk. Consider equity-based unit trusts if higher risk tolerance and longer investment horizon to rise out the volatility of the market cycle

Fixed Income / Bond Funds: Invest primarily in corporate / government bonds and other fixed income securities. Aims to provide a regular stream of income for investors. High yield bonds are for those with more risk tolerance. Just like equities, global bonds are lower risk. Risks are also dependent on credit quality of issuers and duration of bonds in the fund. Duration measures the sensitivity of price of bond to change in i/r. Bonds with longer duration would be more sensitive to price changes due to change in i/r and thus riskier than shorter duration bonds

Balanced Funds: Typically consists of investment in equity and fixed income securities with varying weightage on the two asset classes. Aims to provide long term capital growth by allowing manager to allocate funds differently in accordance with market expectations. Suitable for moderate-risk investors as it contains risk of both asset classes

Money Market Funds: Substantially have all assets in short-term deposits with financial institutions and money market instruments or debt securities with maturities less than one year. Small portion (<10%) in permissible securities with maturity of < 2 years. Suitable for investors looking for returns higher than fixed deposits with much less volatile than bond/equity funds. Credit risks however, still prevail

Fees Paid By Investor

Initial Sales Charge (‘Front-End Load’): Fee is charged when buying a unit trust. Is retained by distributor as their remuneration for selling the unit trust. Fee ranges from 0% (for money market funds) to 5% on initial investment amount. Sales charge for CPFIS removed entirely since 1/10/2019

Redemption / Realisation Charge: Charged if investor redeems within a predefined period. Usually 1% to 5% of investment and is charged whenever you sell / redeem the fund. Some unit trusts may progressively reduce this fee if you hold onto it longer

Switching Fee: 1% charge on allowing investors to switch/change to another fund managed by the same fund manager at a reduced cost

Fees Paid By Unit Trust

Paid for by unit trust which will reduce returns on your investment

Management Fee: Fund manager for providing expertise. 0.5% to 2% p.a. of NAV of the fund

Trustee Fee: Charged by trustee for provision of custodian services for fund’s assets. 0.1% to 0.15% p.a. of NAV

Expense Ratio: Total operating expenses charged to fund as a % of funds average NAV for the year. Components include custody, legal, audit, valuation, management & performance fees. Calculated to ensure investors are properly informed of all relevant costs. Also enables comparison among fund managers with different costs

Pricing of Unit Trusts

Bid & Offer Pricing: Offer is price which investor pays when buying units. Bid is price which investor gets when selling units. Difference between offer and bid is spread, which is the sales charge retained by distributor

Single Pricing: Only one price, NAV. Sales charge is first deducted from investment amount before remainder is used to purchase units at prevailing NAV

Cancellation Period: No penalty for cancelling purchase if done within 7 calendar days of trade done. If unit trust suffered loss, you would suffer that loss, and if it made a gain, you only get a full refund. Right to cancel is unavailable if you are making additional investments in a unit trust you already own

Structured Products

Intro to Structured Products

Complex financial instruments which pay investors returns based on performance of an underlying asset, according to a pre-set rule. Underlying assets include stocks, stock index, i/r, commodities, credit derivatives or a basket of these. Credit derivatives are privately held negotiable bilateral contracts that allow users to manage their exposure to credit risk. They are financial assets like forward contracts, swaps and options for which price is driven by credit risk of economic entities. Option: Contract which gives the owner the right to buy / sell the underlying asset at a specified strike price or before specified date

Types

Wrappers are the legal form in which a SP is offered to investors. Usually wrapped as: Structured deposit, fund, note, investment-linked

Structured Funds: Can only be managed by an asset management company with a Capital Markets Services license. Combines equity, fixed income & derivatives to achieve specific risk/return profiles that in the marketplace would be hard to attain. Credit derivatives are financial instruments that derive value from underlying entities. Derivative transactions include a variety of financial contracts, including swaps, futures, options and forwards. SFs with fixed income component are designed to provide some level of capital preservation via principal repayment, along with interest payments (no guarantees on return of principal at maturity)

Structured Notes: Debt instruments that link possible coupon payments or the market value of the notes to performance of underlying assets. Usually have 1 or more embedded options or may employ other derivatives strategies. Financial institutions can directly issue SNs or do so via a Special Purpose Vehicle (SPV). Direct issuance: FI offers notes to investors who bear the credit risk. SPV is legal entity created to fulfil narrow, specific or temporary objectives. SPV is usually set up to serve as counter-party for swaps and other credit-sensitive derivative instruments. SPV issues notes to investors, proceeds are used to buy fixed income securities (like zero-coupon bonds, debt securities, or other asset-backed securities) either to preserve principal capital or use them as collateral against the options or credit insurance which they sell to the market. SPV: investors bear credit risk of assets held by the SPV and risks of performance of linked assets but bear no direct credit risk of the FI that sets up the SPV. Zero-Coupon Bond: a debt security that does not pay interest (or coupon) but is traded at a deep discount, rendering profit at maturity when bond is fully redeemed for principal value. Asset-backed securities: income payments and thus, value is derived from and backed by a specified pool of underlying assets. Most SNs consist of principal and return

Earn additional yield in yield-enhancement products by selling options to collect premiums to be added on to the interest earned from PC.Depending on strategy, various FIs in RC can be combined to provide predetermined fixed or unlimited returnsf capital in the SN, so that part / whole investment amount returns to investor at maturity. Unless bond issuer defaults, the par value of the bond will be repaid in full ensuring principal invested is returned to investor. Can also be used as collateral to provide guarantee to credit default swap (CDS) being sold to enhance the returns of the SN. This yield-enhancing action increases risk of PC and thus, the risk of SN. CDS is a swap designed to transfer credit exposure of fixed income products between parties. CDS aka credit derivative contract, is where the purchaser of the swap makes payments till maturity. Payments are made to the seller of the swap, and in return the seller agrees to pay off a 3rd party debt if this party defaults on the loan. CDS is also considered as insurance against non-payment as a buyer of . CDS might speculate on possibility that 3rd party will indeed default

Return Component (RC): Usually comprised of derivative instruments relating to stocks, credit, forex, etc. Gains exposure to particular view of underlying assets in order to earn the returns when the view is right. Earn additional yield in yield-enhancement products by selling options to collect premiums to be added on to the interest earned from PC. Depending on strategy, various FIs in RC can be combined to provide predetermined fixed or unlimited returns

Tenor, Coupons & Return Payout Structures

Most SPs have fixed tenor with cash redemption at maturity. Some may have callable (or early redemption) feature, or redeem early if a knock-out condition is achieved, or upon the occurrence of a credit default event. Some SPs may have terms permitting redemption at maturity in form of underlying assets or in a currency other than currency the SP was originally denominated in, in lieu of being redeemed as cash. Knock-out is a feature linked to an option with a built in mechanism to expire worthless should a specified price level be exceeded. Credit default event: financial event related to a legal entity which triggers specific protection provided by a guarantee or credit derivative. SPs may commit a min redemption of principal at maturity such structures usually entail purchasing a zero coupon bond and options. Coupons may be fixed, floating, inverse floating, daily accrual, step up, step down or even zero. Inverse floating coupons move opposite to that of floating i/r. Daily accrual accrues interest for each day the underlying asset stays within a specified range. Options used may be vanilla or exotic. SPs employ either long or short or a combination of long & short option strategies and with various exercise prices and tenors so as to achieve desired coupon and pay-out profile. Term sheet, a non-binding agreement setting forth basic t&cs provides info on underlying assets, maturity tenor, coupon and pay off formula

Types of Structured Notes

Equity-Linked Note: Linked to single stock, a basket of stocks, stock index or a basket of indices

Risks: Performance of basket may not be based on average return of basket, but performance of worst performing stock / stock index in basket. Notes may cap returns if underlying stock performs far beyond expectations. SNs contain an option to pay back investors in the form of shares when notes mature but investors may end up buying shares at a price higher than the prevailing market price. If early redemption conditions are met, one may use a ‘Knock-Out’ or ‘Trigger’ event which are deemed to have occurred if underlying shares close at or beyond the relevant knock-out/trigger price. Notes would be redeemed early at 100% + relevant coupon payable & investors are no longer be no longer exposed to risk of underlying shares

Example: SN linked to shares of a hi-tech company, notional investment of $10,000, purchase price of ELN is 90% of the notional, tenor is 1 year, 100% of notional sum or 10,000 of shares at maturity, current price $1.20, strike price $1.00. Best case: share price on maturity is at or above the strike price, investor receives $10,000 (11.1% yield). Moderate case: share price on maturity below strike price e.g. $0.95, if t&cs specify a cash settlement, if t&cs specify physical settlement shares will be received. Worst case: price reaches zero. A ‘worst of’ ELN is linked to more than one underlying stock or index and return depends on the performance of the worst. Such ELNs pay higher yield due to exposure to more risk

Credit-Linked Note: Linked to ‘credit events’ (e.g. a specified company becomes insolvent / defaults on loans) and/or linked to credit risk / market value of underlying collateral

Risks: Exposed to credit risks of specified reference entities. Must assess the likelihood of credit events occurring. Reference entity is the underlying party involved in a credit derivative contract. Reference entities bear credit risk

Structured Deposits

Intro to Structured Deposits

Investment that is a combination of a deposit of one or more option contacts where return is dependent on performance. Typically includes market indices, stocks, i/r, bonds, forex or combination of these. Option contracts: contract which gives the owner the right to buy or sell the underlying asset at a specified exercise price or before a specified date

Features

Minimum Deposit: Usually $5,000 depending on banks

Maturity: 2 weeks to 10 years

Principal / Capital: Repaid in full at maturity. Or if bank redeems it before maturity when given the option to

Returns: Higher risk and potential returns than fixed deposits. Return depends on performance, ‘Cap’ rate, ‘participation’ rate. Cap rate will limit your maximum returns e.g. capped at 30%, 40% index rise thus you get 30% returns. Participation rate will limit your returns of the index e.g. p/r 50%, index rises by 30% thus you get 15% returns. Some may incorporate both rates in calculation of returns

Early Redemption & Guaranteed Payout: At bank’s discretion or if certain conditions are fulfilled, you may redeem or call the investment before maturity. Call: expect at min. full value of principal. Call can be auto call or discretion

Example 1

5 year SD linked to equity index vs bond. Every 6 months, performance of equity and bond index is compared. I/r of 4.5% p.a.is paid if equity > bond, no interest paid if equity < bond. SD is terminated early upon Trigger Event. Trigger event: performance of equity > bond by 20% or more. Upon early termination, investors are repaid 100% of principal amount + accrued interest

Example 2

5 year SD i/r up to 3.8% p.a. Year 1: 3.8% i/r. Year 2 to 5: i/r accrues daily with no compounding when the 10-year SGD i/r swap (IRS) > 2-year SGD IRS by 0.85%. I/r payable = 3.8% p.a. * N1/N2

Where N1 is the no. of calendar days in each interest period when 10-year IRS > 2-year IRS by 0.85%

Where N2 is no. of calendar days in the relevant interest period

I/r payable ranges from 0% p.a. to 3.8% p.a. depending on market. Issuer has right to early terminate SD every quarter on every interest payment date. Full principal repaid to investors at maturity or as when bank early terminates investment

Risks

Market Risk: Performance depends on underlying assets which fluctuates with the market

Liquidity Risk: Ties up your funds. If you choose to withdraw before maturity, you may only do so at designated redemption dates or risk losing part of your return and/or principal

Premature Redemption by Investors: Principals will be repaid fully only when held to maturity. Only entitled to an amount equivalent to the full principal amount less any breakage costs incurred due to termination, if withdrawn before maturity. Thus, Invest in SD only if you intend to keep the money there till maturity. Breakage costs: costs, expenses, liabilities incurred by bank due to breaking its hedge, or funding arising from investor’s request for early redemption

Reinvestment Risk: Unable to reinvest funds at the same rate as original investment upon receiving interest payments or principal amount back

Issuer Risk: Credit risk of bank e.g. default, bank unable to repay. As SDs are not ordinary deposits, they are not covered by the Deposit Insurance & Policy Owner’s Protection Scheme Act 2011 of Singapore

How SD Are Different from Fixed Deposits

For FD, I/r and maturity are fixed upon placement. SD returns may vary & investment tenor may vary due to early termination by issuer. FD are covered under DPS unlike SDs

Factors to Consider

Liquidity: Funds tied up

Risks: SDs are riskier than FDs, know your risk appetite

Returns: Understand markets

T&Cs: Understand what you’re buying in to

Dual Currency Investments

Intro to Dual Currency Investments

DC involves a base currency, an alternating currency and an option in the currency pair. Returns are derived from premium of the option being sold to achieve the yield enhancement. Invest principal amounts into base currency & depending on the exchange rate, bank may pay out the principal + interest in another currency (‘alternative currency’) based on pre-agreed exchange rate. Offers higher i/r than traditional forex FD. Base currency: currency placed with bank. Alternative currency: currency received at end of tenor. Strike/Exercise price: level to convert base to alternate. Fixing date: date where currency rate is observed. Prevailing exchange rate on fixing date is compared with strike price to determine which currency you receive

Example

Sum: 100,000. Base: SGD. Alternate: USD. Tenor: 1 year. I/r: 6%. Strike price of USD/SGD rate: 1.2800 (current rate: 1.3200). Total sum in USD to be received if rate goes below 1.2800 = SGD 100,000 x 1.06 / 1.2800 = USD 82,812.50

Best Case Scenario: USD trades above 1.2800, option not exercised, interest earned is 6%. Receive SGD 106,000 at maturity

Moderate Case Scenario: USD trades between 1.2075 and 1.2800. Receive USD 82,812.50. Earn more than SGD 100,000 as break even is at 1.2075

Worst Case Scenario: USD trades below 1.2075. Receive USD 82,812.50. Loss is made

Risks & Suitability: Exchange rate risk. DCI might provide opportunity to earn potentially higher i/r than time deposits for an investor who has a natural demand for the alternate currency

Fees: No additional fees or costs for both SDs & DCIs