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BNP Paribas issues credit-linked note backed by China Development Bank CDS
The challenging market environment with its persistently low interest rates and heightened volatility is making fund managers go for enhanced long-short strategies in order to boost yield.
Bayani S Cruz 25 May 2016

The challenging market environment with its persistently low interest rates and heightened volatility is making fund managers go for enhanced long-short strategies in order to boost yield.

 

Although diversification is probably the best strategy in this kind of market environment, BNP Paribas believes that long-short strategies and hedge funds have become more important in terms of enhancing yields on an equity portfolio at this time when the upside for equity is limited particularly, US equities.

 

BNP Paribas has come out with a five-year note which is based on a long-short strategy index with a five-year track record, fairly long by indexing standards that had been performing well in the past year.

 

Known as the Guru long-short index, this index managed by BNP Paribas has outperformed its reference indexes posting an average return of 6.3% over a five-year period an annual-return-to-annual volatility ratio of 0.77%.

 

Based on the Guru long-short index, the five-year note - known as the Guru Plus - takes the positive performance of the index. This mean only the positive performance of the index will be paid to the investors at the maturity of the note effectively making it into a capital protected note.

 

"We still have a long bias. So if the equity markets have a positive performance, this index will benefit partly from the positive performance. But if the market goes down then the portfolio will be protected through this long-short index, which is rebalanced every month and through the short sell strategies of the index," explains Arnaud Tellier, head of investment services at BNP Paribas Wealth Management in an interview with The Asset.

 

In addition, a coupon of 1.5% is paid annually to the investors. This means that the yield of the note is not only based on the market index, but also on an annual income from a credit default swap (CDS) on China Development Bank that is embedded in the note.

 

China Development Bank was chosen because it is a well-known name in Asia as one of three policy banks of the China. Debts issued by this bank are treated as risk-free assets similar to China-issued government bonds. The bank has a credit rating of AA-minus, which is higher than that of BNP Paribas.

 

"Gurus Plus is a combination of an index note on that long-short equity strategy and a credit linked note on an AA-minus name, which allows Guru Plus to pay an annual coupon of 1.5% in addition to the perceived performance of the index. We believe that it's a strategy that is well-suited to the current changing environment," says Tellier.

 

The investment strategy for Guru Plus is part of an asset allocation strategy based on the fact that most of BNP Paribas Wealth Management's clients are overweight on equities and bonds.

 

"Instead of adding to that asset allocation, we advise them to diversify their allocation through these kind of strategy," Tellier says.

 

The only risk that comes with the Guru Plus is the credit risk that comes with the issuer of the CDS. But since China Development Bank has an AA-minus credit rating, the credit risk that comes with its CDS is negligible. Also China Development Bank's CDS is very liquid and one of the best rated in Asia.

 

Designed for private banking clients, Guru Plus can be leveraged up to 80%. Although there is no minimum investment required, the lowest investment amount to make it feasible would be US$100,000.

 

 

 

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