Hunt for cover as inflation storm blows at nest eggs

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Banks offering variety of products to priority clients, but it's a trade-off between risk and yield
By GENEVIEVE CUA

Tactical yield plays appear to be the order of the day among priority banking clients, as inflation jitters drive them to seek higher yields for idle cash.

Banks report a surge in the take up of 'premium currency' investments, where clients can profit from positions on currency pairs. Some banks like Standard Chartered Bank and DBS report a quadrupling of the volume of dual currency products.

Take-up of structured notes is also reportedly strong, particularly for structures with a fixed coupon feature and capital protection. Clients also want a call feature where the product could be unwound early. Stanchart, for example, reports around US$1 billion in sales of structured products between the fourth quarter of 2007 and the current period.

Ironically a good number of the products still do not adequately compensate clients for inflation. Dual currency investments are typically very short term option contracts of up to a month, giving clients flexibility on reinvesting their money. But structured notes may have a holding period of two-and-a-half to five years. This suggests that clients could be stuck with negative real returns for a fairly long time if inflation trends are sustained.

Citibank head of wealth management Salman Haider says: 'Markets have priced in a severe stagflation scenario. We don't think that will come to bear. A slowing of the US economy will help temper inflation... We're seeing a shift across the board as clients look for more liquid instruments.'

DBS managing director and head of Treasures priority banking Pearlyn Phau said: 'We think the second half outlook will be more positive compared to the first half. Rates will trend upwards, and inflation should taper off towards the end of the year as the global economy softens. Markets are now looking for a bottom.'

Priority banks cater to clients with investible assets of at least $200,000. Sitting in between mass banking and private banking, the segment is a growing and competitive one. Typically clients enjoy wider access to a variety of products that would not be available to mass banking customers.

While dual currency investments have long been a staple among priority banking products, Citibank and Stanchart have added a twist. Now clients can use gold as an alternative asset to the US dollar.

Citi launched its gold-linked premium account in January, and Mr Haider said take-up is 'pretty good and increasing'. Stanchart launched its facility in June. To date it has attracted US$40 million in funds.

Janice Poon, Stanchart general manager (wealth management) said: 'We structured (the gold-linked premium account) for the benefit of clients holding US dollars.'

The gold premium account works in a similar way to FX premium accounts where the client should be indifferent as to holding either of two currencies in a pair, or in this case to holding gold or the USD. The client will typically agree upon a strike price - this time for gold - and an interest rate. If the gold price moves above the strike at the end of the tenor, the client earns his principal plus interest. If gold drops below the strike, the client's principal and interest are converted to gold at the strike price.

On a recent structure by Stanchart, a client could earn an interest rate of 9.4 per cent per annum for a two-week tenor, or 10 per cent per annum for one month.

Meanwhile, structured products like Merrill Lynch's Jubilee Series paying 2.7 per cent in coupon over 2.5 years reportedly drew strong interest. Said Stanchart's Ms Poon: 'The market has been pouring money into very simple fixed rate structures with capital protection.'

But Singapore's inflation rate hit 7.5 per cent in April and May and the forecast has been raised to 5-6 per cent for 2008. With the structures, investors are still grappling with negative real returns.

Ms Poon said: 'If you are really concerned about inflation, you have to adjust your risk expectations. Nothing will give you a whiz-bang return in a very short period. If clients are unable to adjust their risk expectations, their yield expectations have to go down. That's why the structures sell well; they pay a higher rate than fixed deposits.'

On the Monetary Authority of Singapore's Opera site, a slew of structured products have been lodged, which are interest rate, credit or equity-linked. The notes pay coupons of between 2.7 and over 7 per cent for holding periods ranging from 2.5 to around 5 years.

Mr Haider says Citi clients are advised to have a three-pronged approach. One is to have an inflation hedge, which could be in the form of a commodities exposure. The second is to have assets that smooth out volatility, such as hedge funds.

'The third is that in the environment of negative real rates, make sure your strategic cash is getting more than money market returns, and not just sitting there eroding in value.'