Dual Currency Investments are picking up in popularity here. -myp
Tue, Apr 26, 2011
my paper
By Reico Wong
DUAL Currency Investments (DCIs) are again picking up in popularity here as investors' appetite for structured products shows signs of returning, in stark contrast to the time when they were avoided like the plague after the failure of Lehman Brothers in 2008.
Experts say the volatility in the world's major economies and their currencies following the financial crisis has, over time, drawn investors back to the asset class, particularly as they search for higher yields as numerous central banks cut rates aggressively to stimulate their economies.
Indeed, as a subset of the structured- notes class, DCIs allow investors to capitalise on narrow currency movements and are said to be attractive as they are liquid and transparent. More importantly, they have the potential to earn investors substantially higher interest rates than vanilla deposits.
Interest rates paid out under DCIs could be as much as 10 per cent per annum or even higher, compared to the less than 0.5 per cent currently offered for traditional time deposits.
But like all investment products, they come with their own set of complexities and risks - and because a larger investment principal is required and the volatility of the asset class here is higher than average, DCIs are typically offered by financial institutions only to high-net-worth individuals with a larger risk appetite.
DCIs, essentially, are non-principal protected structured products, on which the return on investment is subject to the fluctuation of foreign-exchange rates. Investors may suffer substantially or even lose their principal completely due to the depreciation of the alternative currency.
They thus should not be deemed as a substitute for a regular term deposit, experts caution.
How exactly do DCIs work?
Investors basically have to pick a currency pair - a base currency in which their principal sum is in, and an alternative currency which they are comfortable holding.
The US dollar, Australian dollar and New Zealand dollar are usually the more popular currencies among Singapore DCI investors.
A tenor for the investment must also be selected, and this could range from as short as one week to a year.
Lastly, investors must select a strike price, also known as the target conversion rate. They must also accept the interest rate stipulated by the financial institution.
On maturity of the investment, investors will receive the principal plus interest earned in either the base or alternative currency, at the pre-agreed strike price.
Note that early redemption of any portion of the DCI is typically not permitted within the duration of the tenor but, where it is allowed, it is subject to unwinding cost.
Let's take, as an example, that I have US$100,000 and I choose the NZ dollar as my alternative currency for a one-month tenor. I then fix my strike price at 0.812 at an interest rate of 12 per cent per annum.
There are two scenarios upon maturity. Firstly, if the NZ dollar appreciates to above 0.812 against the US dollar at the end of the month, I'll receive my principal together with interest back in US dollars. This will be a total of US$101,000.
However, if the NZ dollar is still less than 0.812 against the US dollar at the end of the month, I'll receive my principal together with interest back in NZ dollars. This will be NZ$124,384.23 [US$101,000/0.812].
Note that the financial institution has the right to repay you in the alternative currency you picked initially, regardless of whether you wish to be repaid in this currency at that time.
Assuming that the current NZD-USD rate on the date of my investment maturity is 0.801, converting NZ$124,384.23 back to USD would result in me getting only US$99,631.77 (less than my initial US$100,000).
Investors thus have to remember that the return on DCIs is strongly affected by politics, economics and other current-affairs situations in the global arena.
"For investors looking to invest in currencies or DCIs, there is no substitute for learning as much about the product as they can," said Mr Wyson Lim, head of wealth management in Singapore at OCBC.
"Sophisticated customers with knowledge of foreign exchange may be best suited for these products."
Mr Greg Zeeman, head of personal financial services at HSBC bank, added that DCI investors need to be aware of the probability of their base currency being converted to their linked currency.
"They must ensure that they have the stomach for the foreign-exchange risk, and have a view on the foreign-exchange movements that they would like to capitalise on," he said.
"To minimise potential risk and loss, investors should invest in a linked currency that they have a natural need for, such as the currency of a country that their children are going to study in or if they conduct business transactions in the alternative currency."
Investors ultimately need to be comfortable holding both currencies for the longer term and they should not be overly concerned whether they receive their capital and interest in either currency.
In general, analysts expect the broad-based US-dollar weakness to continue, especially against its stronger Asian counterparts, including the Singapore dollar. The Sing dollar is widely expected to appreciate to at least about 1.22 against the greenback by year-end.
HSBC said that regular demand for commodities with robust growth in the Asia-Pacific region will be a long-term positive factor for the Australian dollar.
"However, at current levels, the AUD looks slightly overvalued and retracement is likely in the coming months.
The currency may be hard-pushed to give up its gains if the current 'risk on' market environment continues," said Mr Zeeman. "Our year-end forecast for AUD-USD is 0.85."
Meanwhile, the NZ dollar has rebounded strongly after the earthquake as the "risk on" market environment and positive domestic data helped to push the currency higher.
The currency is predicted to pull back from its recent levels and hit 0.72 NZD-USD by the year-end, said HSBC.
reicow@sph.com.sg
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