WHICHEVER way you look at it, an investment fund or note that trumpets a 'protected' stamp is very clever marketing. As recent events have painfully shown, it is a misnomer and the description should be banned from fund or investment product literature.
Protected and guaranteed unit trusts first made their debut in 2000 when the market was rocked by the bursting of the technology bubble. Fund managers who offered them raised billions of dollars, the bulk of which have since matured to a mixed record by now - that is, most of them delivered the capital and no more after 3-5 years.
At worst, those that set out to protect or guarantee 70-90 per cent of investors' capital - on the grounds that a lower level of guarantee allows the manager to take on more risk and deliver more returns - finished at just what they set out to secure. That outcome is disappointing. Who would be happy with just 70-90 per cent of his capital after 3-5 years, when a deposit would have delivered the full capital plus an interest rate, albeit piffling? What's more, the outcome is actually a loss when a sales charge is factored in.
The subscription rate of capital-protected unit trusts in fact pales in comparison with retail structured notes, as investors took to notes even more feverishly. Notes, as you would know by now, are hardly regulated, if at all. Unlike unit trusts, there appears to be no minimum credit rating for underlying securities; little disclosure of what exactly the funds are invested in; and absolutely no disclosure of fees. That opened the marketing floodgates.
But first, back to basics on the distinction between protected and guaranteed products. A protected fund or note relies on the strength of the underlying securities or bonds to deliver an investor's capital. This suggests that the most robust of products would go for the highest AAA-rated securities.
To call itself guaranteed, on the other hand, a fund or note needs an institution to underwrite the maturity value.
A crisis situation like today's illustrates just how illusory protection really is. And the flimsiness of the structure was engendered not only by product manufacturers (fund managers and investment banks) but also by relatively loose regulation.
On the product side, structuring a protected fund in the last few years was a challenge because of the low interest rate environment, particularly in Singapore dollars. So, fund managers and banks trawled from lower-quality credits - with at least minimum investment-grade ratings - to put together a basket that would in aggregate deliver an attractive yield. This included reaching into complex structured debt which also fetched higher yields because of their implicit risks.
The big question - even at that time - was whether there was enough cushion in terms of credit quality to secure investors' principal. As we can see now from various structured products whose mark-to-market values are alarmingly low, the answer is clearly no.
As for regulation, the Monetary Authority of Singapore's (MAS) code for collective investment schemes typically sets a concentration limit of 10 per cent for a single security for unit trusts. With lobbying from the fund management industry, this was loosened for structured funds to one-third. This was arguably something that worked against investors' interests. Diversification helps to preserve principal.
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