Hong Kong: Evolution of Guaranteed Funds 

November, 2004 -

Based on the statistics prepared by the Securities and Futures Commission (SFC), as of early November 2004, there are approximately 280 SFC authorised guaranteed funds. This number has continued to grow throughout 2004. Background The early guaranteed funds introduced to the Hong Kong market in late 1999 offered simple investment strategies securing a capital guarantee with a potential up-side linked to the performance of underlying assets. To a certain extent, this remains the basic formula. Distributors and investors are now expecting more from guaranteed funds. Guaranteed funds began to pay coupons throughout their investment period and these coupon payments eventually became guaranteed coupons. The most common feature for recent guaranteed funds is to have one or two guaranteed coupon payments during the first or second year of the fund with periodic coupon payments during the remaining life of the fund. Whilst most of the guaranteed funds are still investing in debt instruments combined with a call option strategy, in the past year, some guaranteed funds have offered innovative features to retail investors. Target redemption Towards the end of 2003, the Hong Kong market saw the first target redemption guaranteed fund whereby the fund matures when investors receive a guaranteed minimum amount of coupon payments. The original target redemption guaranteed funds could terminate after as little as two years and at the latest 10 years after their launch. The first few launches were very well received but demanding investors are expecting more. The maximum life of recent launches of target redemption guaranteed funds are much shorter - typically around five or six years. Also, target events are no longer dependant exclusively upon the amount of coupons payments received by investors: termination may depend on the performance of the underlying assets. Continuous guaranteed fund During the summer of 2004, an open-end continuous guaranteed fund was launched. The offer period of a continuous guaranteed fund is not limited to just a few weeks; investors may invest into a continuous guaranteed fund even after its initial offering period and the fund does not have a fixed life. The level of guarantee will be reset each year based on the net asset value of the fund in the previous year with the guarantee level floored at 50% of the initial issue price. Early capital repayment Soon after the launch of the continuous guaranteed fund, another innovative feature was introduced to the market. Whilst conventional guaranteed funds will only repay capital investments upon maturity, a new guaranteed fund that was launched last July will start to repay 25% of the capital invested as from the end of year 3 until its maturity in year 6. Upon maturity in year 6, an investor will have received four equal payments of 25% of his capital investment (i.e. a total of 100% of the capital investment by maturity). The aim is to provide greater flexibility to investors in terms of cash flow. There appears to be little sign of a decline in investors’ appetite for guaranteed funds, and the distributing banks’ deposit base remains overswollen, so it will be interesting to see what new features for guaranteed funds develop in 2005.


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