HK family offices: ELNs, FCNs preferred as they provide ample liquidity

Panellists kicked off a webinar organised by the Family Offices Association Hong Kong on 29 April with the latest high-profit antitrust penalty imposed on Chinese tech giants, Tencent and Alibaba. The news about the two household names is too important for Hong Kong investors to overlook as a majority of his family clients who are interested in equity have positions in the stocks, according to Derek Cheung, head of EAM department at Topaz Financial Group.

“The portfolio is not well balanced if we don't have any position on Alibaba. If we have too much on this stock, we might be exposed to too much political risk,” said Cheung.

The interest rates can’t be zero forever. There will be a time to dance - Edmond Lau, Far East Consortium International

Edmond Lau (pictured), senior investment director of Far East Consortium International (FECI), a Hong Kong SAR-based listed real estate firm, said the single family office has for a long time been accumulating positions on Tencent and Alibaba as favourite representatives of the tech sector. Between half and one-third of the overall equity exposure is accessed through structured products. 

“We use structures like ELNs [equity-linked notes] and FCNs [fixed coupon notes], which enable us to customise our target limit on the upside and downside. That's one way we express our view that I think will pretty much fit in the scenario,” said Lau.

In the derivatives space, the consortium founded by late Hong Kong entrepreneur Deacon Chiu often uses interest rate swaps for its bond portfolio, which accounts for the second largest proportion of the total portfolio after real assets.

“We [traded] that in 2018 and later again in 2020. The interest rate can’t be zero forever. There will be a time to dance,” said Lau. “But at the same time you can not stop investing in bonds as that's the only way to hedge your interest rate risk.” 

According to Lau, the family office's portfolio allocations are generally conservative with a focus on investment-grade bonds, which help manage the tail risk - one of the most significant risks in the market along with liquidity risk.

“When the market is liquid, we are able to sell more real assets and have more cash flows to deploy into other asset class,” he said.

The real estate company sets an investment limit for each asset class, including real assets, bonds, equity, FX and rates, commodities and funds, on a quarterly basis - sometimes monthly depending on the rate environment, real estate market and overall economy.

At Topaz Financial Group, structured products are mainly used for yield enhancement against cash. As an example, the multi-family office may split US$100 half for Tencent cash equity and half for ELNs or FCNs linked to Tencent shares.

“Investors may prefer buying the stocks directly when the price goes up, but we will try to balance because there's no sure win,” said Cheung, adding that Tesla has always been in the multi-family office's portfolio. 

He also highlighted an index designed for institutional investors tracking a benchmark fixed income allocation without disclosing the index name. It was linked to a bespoke structured note, which proved that structured notes can be act as an 'efficient coupon-paying product' in the portfolio.

“Instead of having the coupon being invested back to the bonds, clients get a certain percentage of coupon on a quarterly basis. That’s definitely for mid-to-long term position in clients’ portfolios,” Cheung said, adding that the index was designed for institutional investors and is lower cost than mutual funds.

“With a benchmark allocation, you can capture the market and have that diversification,” said Cheung. “It's not a bad alternative, particularly for clients who want to have more passive allocation.”

He noted that the uncertainty about the antitrust news about the Chinese tech giants are already out and digested by the market in some way which could make structured products more attractive as the volatility and liquidity rise.

Volatility

“I would advise to look beyond the short-term windows and try to pick cyclical winners,” said Edward Liu (right), head of investment services of Goldhorse Capital Management. “I think in the US, Hong Kong SAR and China, there will be sector rotation this year. It can be value. It can be growth. It’s a dynamic time right now because [the economy] is rotating and there’s ample liquidity.”

Structured products can help mitigate the risk in portfolios by forecasting price volatility, according to Liu.

“We’ve started seeing some cases of Covid-19 bounce back [in Hong Kong SAR] over the last couple of days, this reminds us that is not over yet,” he said. “There’s over liquidity you have to hedge, which could lead to a lack of yield.”

And Tesla remains ‘the most popular US stock used in structured products for yield enhancement purposes’ due to its high volatility.

“Before February, everyone was talking about stocks being toppish, then you should be cautious,” he said. “At that time, you could sell down your Tesla positions and replace them with ELNs. You profit on the upside and pick up a yield when it goes down. Because you still believe in Tesla for longer time, this is a way to using structured products to help with the portfolio.”

Recently Goldhorse, which owns multi-issuer platform ‘Extramile’ targeting external asset managers, has seen an increasing number of clients quoting bullish structures, such as accumulators and FCNs. For stocks like Alibaba, Liu suggested investors offload some of the risks through decumulators.

“That would allow clients to systematically sell down some shares at a premium price until the contract either knocks out or expires,” he said.

Bonus enhance notes can also come handy when clients hold a long-term view on some stocks, which may have greatly fallen from recent peak, while leveraged curve notes can work well in the current market as investors may bet interest rate is going up and talks about reflationary risk has been on. 

“Most structured products actually have secondary market in a normal way and that is even [traded] on daily basis. You can sell back the product to the issuer when you need the cash,” said Liu. “So that in a way could also manage your liquidity risk as well. And you don't have a lock-up period.”