Investor Guide
Investing wisely means being well informed
Marketing Communication June 2010
Contents
This brochure is neither binding nor exhaustive. Pursuant to Article 36 of the Grand-Ducal Regulation
of 13 July 2007 relating to organisational requirements and rules of conduct in the financial sector, it describes
the main advantages, disadvantages and risks of the principal categories of financial instruments proposed
by BGL BNP Paribas.
Investor Guide
4
Your investor profile guides our investment advice
6
Collective investment schemes
8
Structured products
12
Shares
14
Bonds
16
Alternative investments
22
Cash investments
24
Investor Guide
Investing wisely means being well informed about the nature, advantages and disadvantages of different types
of investments. Naturally, it also means knowing the risks involved.
BGL BNP Paribas places a premium on providing its clients with as much information as possible on the
investments it proposes. By determining your investor profile and analysing the model portfolio that fits you
best, we can help you decide quickly whether an investment is right for you.
The European authorities are of the same mind. The new Markets in Financial Instruments Directive (MiFID)
aims to supply investors with clear, transparent and unambiguous information so that they can make informed
and considered decisions.
This brochure should be read from that standpoint. Inside, you will find descriptions of each type of investment
along with a summary of its advantages, disadvantages and risks.
For any additional information, please contact your usual BGL BNP Paribas adviser.
Above all, a good investment
is an investment that suits
your needs.
5
Your investor
profile guides our
investment advice
Your investor profile is the logical
starting point for a well thought-out
investment strategy. But in order to
advise you properly, we first need
to know your financial situation,
your goals, the level of risk you are
prepared to take, and how familiar
and experienced you are with the
financial world. All this information is
vital for us to recommend investments
that are just right for you.
BGL BNP Paribas uses five investor
profiles, each corresponding to a
clearly defined investment strategy.
Conservative risk profile: capital protection,
very low risk
Your main investment objective is to preserve your capital.
You also want to earn a fixed income from your assets,
which is why you find it more reassuring to invest in
products with fixed maturities and predetermined returns.
Growing your wealth is of secondary importance. You are
willing to take only limited risks with your assets.
The Conservative portfolio is made up mostly of
eurodenominated bonds.
You are aware that the value of your assets can decrease
over a short term period.
Defensive risk profile: gradual capital growth,
low risk
Most of all, you want relatively stable and regular income.
But you are also willing to take a little risk with your assets
to gradually increase your wealth in the long term.
The Defensive portfolio consists mainly of diversified fixed
income securities, with a small portion in shares.
You are aware that the value of your assets can decrease
over a short term period.
Balanced risk profile: balance between risk and
return
Growth/Aggressive risk profile: all-out quest for
growth
Your main aim is to grow your wealth over the long
term. To do so, you are willing to take moderate risks.
Nevertheless, you expect some income on your assets.
The Balanced portfolio is made up of foreign-currency
assets, with equal proportions of bonds and shares.
You are aware that the value of your assets can decrease
over several consecutive years.
Your priority is to generate capital gains. You are aware that
the risks are high and that the value of your investments
will fluctuate. You are not afraid of speculative or emerging
market equities or risky economic sectors. You see a
temporary market fall/setback as a buying opportunity.
Earning income from your assets is of no importance to
you.
The Growth portfolio includes a majority of international
shares.
You are aware that the value of your assets can decrease
sharply over several consecutive years.
Dynamic risk profile: long-term growth
potential
You want to grow your wealth over the long term. You are
willing to take more risks because you want higher returns.
You are aware that shares can fluctuate in the short term
and consider a temporary fall in your investment as a
buying opportunity. Earning income from your assets is of
limited importance.
The Dynamic portfolio includes investments in a variety
of international asset classes, with a high percentage of
shares.
You are aware that the value of your assets can decrease
over several consecutive years.
Once we have met with you and
determined your investor profile, we
will propose an investment strategy
that fits your needs. The rest of
this brochure presents not just the
advantages but also the risks inherent
to the principal assets that you may
find in your portfolio.
7
Collective
investment
schemes
The term “collective investment
scheme” covers several categories of
investment vehicles created to invest
all its capital inflows collectively.
Shares or units – the term depends on
the type of scheme (see below) – are
issued or redeemed at a price called
the Net Asset Value (NAV). This is
calculated by dividing the total value
of the fund by the number of existing
shares/units. NAV is calculated and
published regularly and corresponds
to the price at which investors may
buy or sell units or shares.
Legal form
The Luxembourg regulator, Commission de Surveillance
du Secteur Financier, ensures compliance with investment
rules and also vets the prospectus that informs buyers of
fund units or shares as to the risk inherent to the proposed
investments.
There are two legal forms of collective investment scheme:
·· The Fonds Commun de Placement (FCP) is an unincorporated fund managed by a separate company. The
fund is not a legal entity and is managed under a trust
agreement.
·· The Société d’Investissement à Capital Variable (SICAV)
or Société d’Investissement à Capital Fixe (SICAF) is an
autonomous legal entity incorporated as a company.
Advantages, disadvantages and risks of
collective investment schemes
Advantages
__ Investments in collective schemes provide a high
level of asset diversification. As a result, risks are
spread and the scheme can be managed to generate
higher returns, notably by making optimum use of
the capital raised by professional fund managers.
__ Investors benefit from ongoing active management
by an investment professional.
__ Some collective schemes are organised as umbrella
funds with subfunds. The fees investors are charged
for switching between these subfunds are usually
less than the charge for initial entry.
__ The large number and variety of funds means that
investors are likely to find solutions that will meet
their range of specific needs.
__ Investing through a collective scheme entails
less paperwork than an equivalent investment in
individual securities (for example, when there is a
capital increase, stock split, etc.).
__ The fact that funds invest in a broad array of
securities means that they average out their capital
gains and losses. As a result, during a market
correction, collective schemes generally lose less
ground than certain securities taken individually.
Conversely, during a bullish period, their growth is
less robust. However, given that investments in fund
units are designed to be long-term investments (with
the exception of money market funds), the averaging
effect is not an obstacle to participating in market
growth; it simply eliminates the intervening peaks
and troughs.
__ Most collective schemes have no expiry date,
making them very well suited to (very) long-term
investments.
Disadvantages
__ To be profitable, investments in a collective
scheme must generally be considered longterm investments. This is because funds are
highly diversified, thus reducing the extent of any
fluctuations, and because entry fees can be fairly
high.
__ Substantial diversification in no way guarantees a
positive return.
__ Fees can vary significantly depending on a fund’s
specific characteristics (whether it is, for example,
and equity, bond or money market fund) and the
financial institution marketing the product.
__ Accumulation funds do not distribute dividends and
so are not suited to investors looking to generate
income.
__ When financial markets are rising, NAV generally
rises more slowly than the prices of certain securities
taken individually.
__ Collective investment scheme shares/units are
generally traded only once a day, and in some cases
only once a week or month. This means that it is
difficult to react quickly to a sudden development in
underlying markets.
__ Investors do not have full visibility on the portfolio’s
content, i.e. the individual securities in which it is
invested.
__ In many cases, collective investment schemes
generate cost efficiencies – for example, transaction
fees are lower in exchange for large trading volumes.
It should also be noted that fund units or shares
are generally subject to entry, management and/or
redemption fees.
9
Risks
__ The issuer’s insolvency risk is so low as to be almost
theoretical.
__ Liquidity risk is low. However, in the event of widespread
redemption requests, issuers are legally authorised to
restrict redemptions. Closed-end schemes (closed-end
funds and SICAFs) are not required to redeem shares.
Investors must sell their shares on a secondary market,
where liquidity varies from one fund to the next. In
these cases, the share price often stands at a premium
or discount to NAV.
__ Currency risk depends mainly on the types of assets
that make up the fund. Funds invested in eurodenominated securities have zero currency risk. Funds
invested in securities denominated in other currencies,
like the US dollar, may carry significant risk.
__ Interest rate risk depends on the composition of the
underlying portfolio. It is clearly more of a factor for
funds investing in bonds, but is also present in funds
that invest in other assets, such as equities.
__ Price volatility risk stems mainly from the assets in
which the fund invests. It should be noted, however,
that funds are generally less exposed than individual
securities to this risk because fund portfolios are
inherently more diversified.
__ Income risk is not an issue for accumulation funds
or SICAVs because, by definition, they automatically
reinvest all gains and do not distribute dividends. For
income funds, the dividend varies depending on the
returns to portfolio assets, which may be zero.
10
Other distinctions among collective
investment schemes
Risks
There are no additional risks unique to the nature of funds
of funds.
Accumulation funds and income funds
Capital guarantee funds
__ Income funds
These funds periodically pay out dividends. However,
they are not obliged to distribute all their profits
(investment income and capital gains) in this form.
Funds generally distribute a dividend consistent with
market conditions for each asset category.
Capital guarantee funds are collective schemes that have
a maturity date and which guarantee that a specified
minimum amount will be returned to the investor at that
date. The guarantee may be 100% of the initial investment
(less fees) or any other predetermined percentage.
These funds invest mainly in stocks and bonds. A capital
guarantee fund’s ultimate performance depends on trends
in the value of a specific underlying asset.
__ Accumulation funds
Income is automatically reinvested in the fund, so
investors receive no proceeds from their investments
until they sell their units.
Funds of funds
These are collective schemes that invest in other collective
funds. Fund of fund managers select the best managers in
a given region, sector, investment theme, etc.
Advantages
Diversification is even greater than with a traditional
investment fund. Risks are also spread over an even greater
number of securities.
Disadvantages
Management fees may be high, depending in part on the
level of fees charged by the various underlying funds.
__ The capital guarantee applies only at maturity.
During the life of the product, the NAV may be lower
than the guaranteed minimum amount.
__ The structure that guarantees full repayment of
a minimum amount of capital at maturity often
prevents investors from profiting from increases in
the value of underlying assets to the extent that they
would if there were no minimum capital guarantee.
Risks
There are no additional risks specific to the nature of
capital guarantee funds.
Advantages
__ Investors are able to invest in sometimes very
volatile instruments while keeping risk firmly under
control.
__ At maturity, clients always receive at least the
guaranteed percentage of their initial investment,
regardless of whether the underlying assets decline
in value.
Disadvantages
__ The investment comprises a variety of assets that
exhibit different trends. Over the life of the product,
its quoted price will not necessarily be an accurate
reflection of how the underlying asset is performing.
__ These investments are also less liquid than
conventional funds because their prices are usually
not quoted daily (generally every 14 days or once a
month, if that often). Capital guarantee funds usually
charge higher fees than conventional funds do, and
they may charge a fee for early redemption.
11
Structured products
Designed to generate a specific risk-return tradeoff, structured products are composed of different financial
instruments. The combination may comprise exclusively traditional financial assets like stocks, bonds and/
or currencies. But structured products may also include a combination of conventional financial assets and
derivatives, such as options.
In general, there are three categories of structured products:
-defensive: products that emphasise capital protection and repayment of principal at maturity
-balanced: products that are more closely correlated with market performance and whose principal repayment
is partially or totally exposed
-dynamic: products offering full exposure to financial market movements with no capital protection
Structured products are unique because they combine different asset classes in a single investment vehicle. A
structured product’s ultimate performance depends, however, on the value of a specific underlying asset.
Advantages, disadvantages and risks
Advantages
__ A structured product can be a tailored solution that
fills a specific need or investment goal (such as risk
management) which cannot be met by using a single
financial instrument.
__ Structured products that come with a capital
guarantee offer a low level of risk.
__ The wide range of assets that can be included in a
structured product gives investors access to highly
diversified investment vehicles.
Disadvantages
__ The pricing of structured products can lack
transparency, and their spreads (i.e. the difference
between the bid and ask price) are usually wider
than those of conventional investments.
Risks
__ The issuer’s insolvency risk is not zero. However,
structured products are usually issued by highly
solvent financial institutions.
__ There is some liquidity risk since there is often no
secondary market in these products. If sold prior to
maturity, therefore, they may not command a price
that entirely reflects their intrinsic value.
__ Volatility risk stems mainly from the assets in which
the product invests. However, the fact that structured
products include different types of assets makes it
difficult to anticipate price fluctuations.
__ Income risk depends on each product’s individual
characteristics. When income is expected, actual
payment may depend on movements in specific
assets and on the obligor’s solvency.
__ Currency risk depends mainly on the types of assets
that make up the product. Structured products
invested in euro-denominated securities have
zero currency risk. Products invested in securities
denominated in other currencies, like the US dollar,
may carry significant risk.
__ Interest rate risk depends on the composition of the
underlying portfolio. This is clearly more of a factor
for products invested in fixed income assets.
__ Because structured products are designed for a
specific purpose using combinations of financial
instruments, prices may not necessarily be an
accurate reflection of how the underlying asset is
performing.
__ In certain circumstances, these products may lack
liquidity.
__ Weak liquidity means that it is not always easy to
obtain a satisfactory price during the product’s life
cycle.
__ For products offering a capital guarantee, this applies
only at maturity.
__ The products are often linked with the issuer’s
solvency.
13
Shares
A share, also known as an equity or a stock, represents a percentage ownership conferring rights to a portion
of a company’s capital. Shares may be held in bearer form (and transferred to a third party through a sale) or
in registered form, which means ownership is registered by the company or its agent in the holder’s name.
A share in a company gives the holder certain rights. For example, they can vote at general meetings; they are
entitled to information about the company’s financial position; and they have a claim on the company’s assets
if it is wound up. Shareholders are also entitled to a share of the profits distributed annually by the company,
known as the dividend.
A share’s value is determined by both intrinsic factors related to the issuing company’s development and to
external factors such as the supply of and demand for the shares on the stock market. Supply and demand is
influenced by political and economic events, but also by irrational factors. As a result, it is impossible to predict
share prices with certainty, and they may fluctuate significantly in the short term.
Shares are often grouped together in an index. An index is a list of stocks with common characteristics, which
may include geographic location (e.g. national indices like the LuxX, Bel-20, CAC 40, DAX, FTSE, Dow Jones and
Nikkei), sector or market capitalisation (small cap indices, etc.). Buying equities, regardless of what form they
take, should be considered a long-term investment.
Advantages, disadvantages and risks
Advantages
__ From a financial standpoint, it has been shown that
over long periods of time, equities generate a higher
return (appreciation plus dividends) than bonds.
Unlike bonds, the capital gain generated by the share
over time contributes more to asset returns than
do the revenues distributed by the issuer (i.e. the
dividend).
__ Because shares are highly volatile, they can quickly
generate capital gains.
Disadvantages
__ In principle, equities listed in euros are not subject
to currency risk. However, currency risk can
be significant for shares denominated in other
currencies, like the US dollar. And the issuer’s
business plays a role in this respect, to the extent
that its results may depend on operations outside
eurozone markets.
__ Interest rate risk is indirectly a factor. Interest rate
movements do have an influence on equity markets.
For example, a rise in interest rates makes it more
expensive for companies to finance operations using
debt, which in turn increases their costs.
__ Share prices are exposed to substantial volatility
risk. This is heavily influenced by the quality of
the issuing company, its results and broader stock
market trends. So-called speculative stocks are
subject to greater volatility risk than the shares of a
company with a more stable business (for example,
an electric utility). In this case, there is a significant
risk that even shares held for several years will have
to be sold for less than the purchase price, thus
generating a loss.
__ Equities are clearly subject to income risk because
dividends are variable. For a number of reasons
(weak earnings, financing investments out of
earnings, etc.), companies may even decide not to
pay a dividend in certain years.
__ Shares are a risky investment.
__ Dividends are a variable source of income that
depends on the issuer’s profitability.
__ Fees are charged for every transaction, whether a
purchase or a sale. These fees vary depending on the
stock exchange and the financial intermediary.
Risks
__ Insolvency risk does not apply to shares because
they represent equity in the company. They are
not debt securities, so the issuer is not obliged to
reimburse them. This means that if the company
fails, its shares may lose virtually all their value.
__ Liquidity risk depends on the shares’ trading volume.
The larger a company’s market capitalisation, the
bigger the market for its shares and thus the more
liquid they are.
15
Bonds
A bond is a security that represents a portion of a debt issued either by a government or by a public or private
company. It may be issued at a fixed or variable rate of interest and offers a measure of capital protection,
though no guarantees. In most cases, bond holders receive periodic interest payments called “coupons”.
Bonds are offered to investors during a subscription period. During this period, investors may purchase the
bond at the issue price. This may be higher, lower or equal to the bond’s face, or nominal value (100%) in order
to adjust the yield to market conditions.
Once the issue period is over, bonds may be bought and sold on the secondary market. The market’s liquidity
depends on the size of the issue and the issuer. Transaction prices will thus vary depending on factors such as
interest rate levels (in principle, the price will drop below the issue price if interest rates have risen since the
issue, and vice-versa) and developments affecting the issuer’s solvency since issuance. At maturity, the bond is
redeemed at a fixed price, usually the face value. Bond investments are sometimes referred to as fixed income
investments.
Principal characteristics of conventional bonds
The principal characteristics of a conventional bond are as follows:
Issuer
Types of issuers
The principal types of bond issuers or borrowers are:
__ public authorities (government bonds): government authorities often raise capital on financial markets to
finance their debt or investment programmes. Government bonds are generally more liquid than corporate
bonds (see below).
__ international institutions (e.g. European Investment Bank, World Bank, etc.): these “supranational bonds”
are comparable to the most secure government bonds in terms of risk, but they usually offer a slightly
higher return.
__ companies (corporate bonds): corporate bonds are securities that represent a portion of a long-term debt
issued by a private company, usually a bank (e.g. certificates of deposit). Because they carry more risk than
government bonds, corporate bonds pay a higher return for a comparable maturity.
__ eurobonds are issued by public authorities or private companies outside of their domestic market and in a
currency that may be different from that of the issuer. Eurobonds are usually issued in euros, US dollars,
certain non-eurozone European currencies, Japanese yen, and Canadian, Australian and New Zealand
dollars.
Issuer rating
A credit rating enables investors to judge the quality of an issuer. Ratings give an idea of the
issuer’s solvency at the time the rating is assigned. They are calculated by specialised
independent agencies like Moody’s and Standard & Poor’s. In general, the lower the
rating, the higher the risk and the yield.
17
Ratings issued by Standard & Poor’s and Moody’s
S&P’s
Moody’s
Meaning
AAA
Aaa
The highest credit rating. Given to obligors with an extremely strong ability to meet their interest payment and principal
repayment obligations.
AA+, AA, AA-
Aa1, Aa2, Aa3
Obligors have a very strong ability to meet their interest payment and principal repayment obligations.
Differs from the highest rating only to a small degree.
A+, A, A-
A1, A2, A3
More susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories.
However, the obligor’s capacity to meet its financial commitment on the obligation is still strong.
BBB+, BBB, Baa1, Baa2, Baa3 Adequate protection parameters with respect to interest payment and principal repayment. However, adverse economic conditions
BBB-
or changing circumstances are more likely to undermine the obligor’s capacity to meet its financial commitment on the obligation.
18
BB+, BB, BB-
Ba1, Ba2, Ba3
Significant speculative characteristics with respect to interest payment and principal repayment. While such obligations will probably have
some quality and protective characteristics, these may be outweighed by significant uncertainties or major exposures to adverse conditions.
B+, B, B-
B1, B2, B3
Highly speculative
CCC+, CCC, CCC-
Caa
Highly vulnerable to non-payment
CC
Ca
Obligor is already in default on its obligations
C
C
Non-payment is likely in the short term
D
In default on its obligations
+ or -
1, 2, 3
Indicates relative standing within the major rating categories
NR
NR
No rating: no rating is available
Currency of issue
Subordination
We distinguish between euro bonds, which entail zero
currency risk for European investors in the eurozone,
and foreign currency bonds. Some currencies, like the
dollar, can experience significant fluctuations against
the euro, both upward and downward. Other currencies
are relatively stable against the euro, such as the Danish
krone. The choice of currency also influences a bond’s
interest rate.
Subordinated debt is debt that, should the issuer fail, will
be repaid after all other creditors have been satisfied and
just before shareholders. Thus, it entails more risk than
debt that is not subordinated. The additional risk borne
by the investor can be estimated based on the bond’s
rating, which naturally takes into account the fact that it
is subordinated.
Maturity and duration
Duration is the average maturity of a bond’s cash flows
weighted by its present value. A bond’s duration also
influences its yield. As a general rule, the longer the
duration, the higher the interest rate. Duration is a tool
that lets investors compare roughly several instruments
or fixed-rate bonds and measure a bond’s sensitivity to a
change in market interest rates.
Interest rate
The interest rate level determines the return that will be
paid to the investor. As mentioned above, the interest rate
is set as a function of various parameters such as world
bond market conditions, currency of issue, issuer type and
quality, and duration.
Issue size
The size of the issue is a significant factor in determining
the bond’s liquidity, and thus the investor’s ability to buy
or sell the bond over the course of its life. The bigger
the issue, the more liquid the bond, thus making the
secondary market more efficient.
Advantages, disadvantages and risks
Advantages
__ In principle, this type of investment eliminates
uncertainty (the amount and dates of interim
payments and redemption are set when the bond is
issued).
__ Bonds give investors a higher rate of return than
that offered by short-term investments and a lower
level of risk than that entailed by equities.
__ Bonds enable income-seeking investors to generate
an attractive return.
__ Bond prices, especially those of OECD-country
government bonds, start very low, so this type of
investment is open to all.
__ In addition to steady income, bonds can generate
capital gains when market interest rates drop below
the rate on the bond held by the investor.
__ Bonds can usually be traded readily on a secondary
market.
Disadvantages
__ The capital guarantee applies only at maturity.
__ Over the life of the bond, its value may fluctuate as a
result of various factors, the most important of which
are interest rate levels and the issuer’s financial
situation.
__ Because of inflation, the real value of the principal
repaid at maturity is usually less than its value at the
time of issue. This phenomenon, called “monetary
erosion”, is greater when inflation is high and the
bond’s duration is long.
__ Bonds can be purchased on the initial terms only
during the subscription period. Once that period is
over, the bond’s price fluctuates and purchases will
be subject to intermediaries’ fees.­
Risks
__ An issuer’s insolvency risk varies significantly from
one bond to the next. Bonds issued by OECD member
governments, international institutions and, in
general, issuers with very high credit ratings are
virtually risk free. However, insolvency risk – and
thus the risk that the issuer will default on payment
at maturity – is significantly higher for corporate
bonds. In general, the risk rises as the issuer’s credit
rating falls. It should be noted, however, that ratings
agencies are not infallible, and accidents can happen.
__ Bonds’ liquidity, and thus investors’ ability to buy
and sell them over the course of their life, varies
hugely. It depends mainly on the issue size (larger
issues mean more efficient secondary markets),
trading volumes and the type of issuer. It is usually
easier to trade government bonds than corporate
bonds over the course of their lives.
19
__ Currency risk depends on the bond’s currency of issue.
Bonds issued in euros do not carry any risk for European
investors in the eurozone. However, bonds issued in
foreign currencies are subject to significant currency
risk.
__ Bonds entail a significant amount of interest rate risk,
which can cause the investment to generate a capital
loss. The value of a bond decreases when interest
rates rise, because higher rates make new issues more
attractive. Its value will decrease to a level where the
yield (ratio of interest rate to price) is equal to the yield
of a newly issued bond (generally at par) on the primary
market. As a result, the longer a bond’s remaining life to
maturity, the higher its downside risk.
20
__ Volatility risk also depends on the bond’s remaining life (the longer the time to maturity, the more
vulnerable the bond is to interest rate fluctuations) and changes in the issuer’s financial situation (a bond’s
price will react negatively to a rating downgrade or to factors that threaten to undermine the rating).
Certain types of bonds exhibit specific
characteristics that may alter the
advantages and disadvantages of
fixed income investments, sometimes
significantly.
Zero coupon bonds
Zero coupon bonds do not pay annual interest. Interest
is accrued until maturity. The issue price is deeply
discounted relative to the final payment at maturity,
because it represents the present value of the bond’s face
value discounted at a fixed rate of interest. For example, a
zero coupon bond with a face price of EUR 100 and a yield
of 10% over 10 years will have an issue price of 38.55%.
One could also say that EUR 38.55 invested today at a
compound interest rate of 10% will be worth EUR 100 in
10 years.
Inflation-linked bonds
Perpetual bonds
Inflation-linked bonds are a particular form of indexed
bonds. They pay periodic coupons, like conventional
bonds, but the coupon is paid on a nominal amount that
is adjusted for inflation.
A bond with no maturity date. Many perpetuals are
callable, meaning that the issuer reserves the right at
certain dates or during certain periods set when the bond
is issued to cancel the bond and reimburse the holder at
a predetermined price.
Floating rate notes
Floating rate notes, or FRNs, are bonds with an interest
rate adjusted at set intervals for the coming period (e.g.
every six months for the following six month period). The
conditions for determining the rate are set when the FRN
is issued, generally using another bond as a benchmark.
Stripped bonds
Once issued, bonds can be stripped, which means that
the face value and coupons are stripped into two separate
components and are listed and traded separately. The
holder of the face value component will not receive any
payments until maturity. This system is often used by
insurers to manage the pace of their capital flows and is
practiced almost exclusively on government bonds. Also
known as “strips”, which stands for Separate Trading of
Registered Interest and Principal of Securities.
21
Alternative
investments
Alternative investments are those
that cannot be made using standard
asset classes – bonds, equities and
cash market securities. They are often
highly complex vehicles and exhibit
some unique characteristics in terms
of the risk-return tradeoff. There
are four main groups of alternative
investments:
•real estate
•hedge funds
•private equity
•other alternative products
(including commodities, for
example)
Advantages, disadvantages and risks
Types of alternative investments
Other alternative products
Advantages
Real estate
Gold (gold mining shares)
In principle, alternative investments are only weakly
correlated with conventional investments. As a result,
they enable investors to significantly improve their
portfolio diversification and long-term returns while
reducing risk.
From a financial standpoint, there are five main groups of
real estate investments:
Disadvantages
__ public debt
Gold is the most widely used precious metal for investment
purposes. It is traditionally considered a safe haven in
times of crisis (notably war and political instability) and
a store of value against inflation. This does not mean that
gold is risk-free. The market may experience disturbances
when a central bank sells a portion of its reserves, as a
result of forward selling by mining companies or when a
new deposit is discovered.
__ These types of investments are usually less
transparent than conventional instruments.
__ They are also usually less liquid than conventional
instruments.
Risks
The category of alternative investments encompasses
instruments with very different characteristics. For this
reason, each type of investment usually has very specific
risks associated with it.
__ real estate investment companies
__ public equity
__ private equity
__ private debt
Hedge Funds
Hedge funds are usually organised as collective
investment schemes for legal purposes. The term “hedge
fund” encompasses an array of funds that invest in a
wide variety of assets with significantly different degrees
of risk. The fund manager’s goal is to generate absolute
returns and thus to decorrelate the fund from general
market trends. To meet this goal, the fund may employ a
very wide range of investment tools, including derivatives
such as options, futures, etc. These funds may only be
distributed privately.
Commodities
Investors invest in commodities (a basic good, units of
which are interchangeable) mainly through futures
and forward contracts. Commodities include wheat,
precious metals, oil, natural gas, cotton, coffee, and so
on. Merchants use these transactions to hedge against
potentially unfavourable price movements, and investors
and speculators use them to earn a profit from price
fluctuations on the markets where these commodities are
traded.
Private equity
This term is generally used to describe the capital
supplied to unlisted companies. Private equity may
be used to develop new products and technologies,
boost working capital, make acquisitions, or shore up
the company’s financial situation. It may also be used
to resolve ownership or management problems – for
example, inheritance issues at a family-owned company.
23
Cash investments
Cash investments are short-term
holdings – i.e. 12 months or less –
in euros or foreign currencies. Cash
investments can take a variety of
forms: sight deposits, term deposits,
savings accounts or money market
securities.
24
Advantages, disadvantages and risks
Types of cash investments
Advantages
Euro or foreign currency sight deposits
__ As their name implies, cash investments are in principle
highly liquid. This means that invested capital can be
accessed very quickly without paying a penalty, except in
the case of term deposits.
The sight deposit is the key interface in the bank-client
relationship and is the main avenue for fund inflows and
outflows. This is the basis of all banking transactions.
__ Cash deposits can be used as temporary investments,
for example if the investor expects interest rates to rise.
Term deposits
__ Cash investments allow investors to earn a return on
capital that they are waiting to use for another purpose.
Disadvantages
__ The return on these investments is usually lower
than on investments in other asset classes.
A term deposit is a form of investment in which the client
lends the bank a set amount of money for a predetermined
period of time (usually less than 12 months) in exchange
for a predetermined rate of interest.
Savings account
The savings account is a savings instrument denominated
in euros or some other currency (USD, GBP, etc.) and has
no expiry. Hence, the funds are available at any time.
Money market securities
The money market is a market in which investors trade
debt and loans with a maturity of less than one year (e.g.
Treasury bills). Money markets exist in every country.
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Risks
__ Insolvency risk is usually negligible in the major
industrialised countries because money market
instruments are generally issued by national
monetary authorities, which guarantee deposits up to
a certain amount.
__ Currency risk depends on the currency in which the
investment is made. Debt issued in euros carries no
risk for European investors in the eurozone. However,
debt issued in foreign currencies is subject to
significant currency risk.
__ Interest rate risk is very low because cash
investments have short maturities and can thus
adapt quickly to changes in market conditions.
25
Notes
26
06/10 EN (1) Non contractual document
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