Launched on Singapore Exchange (SGX) in 2017, daily leverage certificates (DLC) have reinvigorated the Singapore-listed structured products market with its wide offering of underlying market indices and single stocks, simple-to-understand and transparent leverage strategy. More than $12 billion have traded on the DLCs since their launch with a significant increase in the first half of 2022 amid heightened volatility in the market (see Chart 1).
As a derivative instrument, DLCs track the underlying index or single stock daily performance with a fixed leverage factor. For each underlying, there is a “Long” DLC and a “Short” DLC for investors to trade both directions of the market. For example, if the underlying index goes up by 1% today, the respective 5x Long DLC would gain in value by 5% while the 5x Short DLC would fall in value by 5%; and vice versa, if the underlying index falls by 1% (before cost and fees).
The DLCs can be readily accessed through a regular stock brokerage account. In other words, the DLCs can be traded on the same broker platform as one would use to trade Singapore stocks. However, do note that the DLCs are Specified Investment Products (SIPs). Hence, investors must be assessed by the broker to be suitable before they can trade the DLCs.
Offering Hong Kong stock market exposure on SGX
The majority of the 250 DLCs currently listed do in fact track the key Hang Seng indices and H-shares, which have risen in popularity over time among local investors. In terms of trading activity on the Hong Kong underlying DLCs from January to July 2022, the five most active based on traded value include the Hang Seng Index (HSI), Tencent Holdings, Meituan, Hang Seng China Enterprises Index (HSCEI) and Alibaba Group Holding (see Chart 2). Naturally, the China tech giants are among the favourites, given how often they attract headlines in the media. However, there is a much wider range of Hong Kong stock such as the old economy, new energy and automotive stocks that investors are slowly catching up to as well.
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The key value proposition of using the DLCs to access the Hong Kong market instead of the buying the actual stock listed on the Hong Kong Exchanges and Clearing (HKEX) is that the DLCs allow investors to gain exposure to the underlying stock with a lower minimum investment sum.
Take the case of BYD Co listed on HKEX. Due to the minimum lot size, the minimum investment sum is around $25,000, which is very high for the average investor, and especially so if they are not planning to take a longterm view; whereas the DLCs, which are generally priced at a fraction of the cost of the underlying stock, allow investors to gain exposure to the same stock with smaller bite-size capital and be able to average into their position.
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Besides the lower minimum investment sum, investors do not have to convert their currency to HKD since the DLCs are all traded in SGD. The broker commissions are similar to that of trading Singapore stocks.
Creating opportunities in a so-called ‘boring’
Singapore market Critics like to describe the Singapore stock market as boring. True, Straits Times Index (STI) and Singapore stocks in general are less volatile relative to other developed market indices and stocks quoted there. We hardly see the STI constituents move more than +/-2% a day. Now, this is where a vibrant structured products shelf like the DLCs can help to add a little excitement to the market.
Offering up to 7x leverage on the STI and 5x on the Singapore stocks, the DLCs can enhance the potential return on the trades (losses are also similarly magnified, however capped at the principal amount) and create opportunities that might not have made sense in terms of risk/reward if the trade is on the actual stock itself.
Also, the long and short DLCs create opportunities by allowing investors to trade both directions of the market. As mentioned in our previous article “Shorting a Bear Market”, this strategy does come with a higher level of risk and should be left for the sophisticated investors only. As for the trading activity on the Singapore underlying DLCs from January to July 2022, the most active based on traded value include United Overseas Bank (UOB), DBS Group Holdings, MSCI Singapore Index (SiMSCI) and Singapore Airlines (SIA). (See Chart 3.)
A vibrant structured product market bodes well for the SGX-listed stock market, and it is part of the evolution of a well-developed stock market as trading activity on the DLCs will generate liquidity on the underlying Singapore stock when the issuers and/ or market-makers hedge the DLC positions on the underlying stock itself and even provide greater price discovery on the underlying stocks. Perhaps, one day the Singapore structured products segment may grow to 10%–20% of the total market turnover, a level similar to the structured product segment on HKEX currently.
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Expanding the range to US stock market indices
There are a couple of recent additions to the range of existing DLC products: the 5x Long and Short DLCs on the S&P 500 and Nasdaq-100 stock indices. We believe these new products are timely given the rising level of volatility in the US market.
The US indices DLCs are for investors looking to gain exposure to the US market via an SGX-listed instrument using SGD and have the flexibility to trade both the long and short directions of the market. The US indices DLCs will be of interest to investors who wish to gain exposure to the US markets during Asian hours. This allows them to get in ahead of the US market open or even hedge their US market positions in the case of high-impact news during Asian hours.
As the US Indices DLCs are only traded during SGX market hours when the US market is closed, they might make more sense for investors who like the convenience of trading on SGX and are comfortable with the fact that they will not be able to manage their positions overnight when the US market is open, and possibly with the intention to hold their position for a few days or weeks.
Since the recent low recorded on June 17, the S&P 500 Index rebounded around +12% from June 17 close to July 29 close. Correspondingly, the 5x Long DLC gained +68% while the 5x Short DLC fell –50% during the same period (see Chart 4).
Compounding effect
It is important to understand the features of the DLCs before trading them and a key feature is the compounding effect. DLCs are designed around the daily performance of their underlying index or single stock. If a DLC is held for longer than one day, the return could outperform or underperform the leverage factor embedded within the product. This is because the exposure of a DLC is reset at the end of each trading day back to its fixed leverage factor, and the returns, or losses, are compounded daily.
The compounding effect can positively enhance returns in trending markets (upwards or downwards) while negatively impacting returns when the markets are more volatile or trend sideways for long periods. The effect of this compounding is further amplified as daily returns are leveraged.
The DLCs are not designed to be bought and held for long periods of time. While investors should continue to build their long-term investment portfolio with other instruments such as stocks or bonds, the DLCs can certainly serve as an efficient “tactical instrument” within your overall portfolio to provide the flexibility needed to navigate the kind of volatility we have seen in the market in recent years.
Marcus Ng is vice-president of cross asset listed distribution, Asia Pacific, at Société Générale
Visit Societe Generale’s website at DLC.socgen.com to see the full list of DLCs and learn more about the product features, including the associated risks of trading the DLCs INVESTING STRATEGIES Chart 1: Surge in DLC trading activity in 1H2022 Chart 3: Top traded long+short DLCs by SG underlyings Chart 4: S&P 500 DLCs vs S&P 500 Index CHARTS: SOCIETE GENERALE (DATA FROM JAN 3 TO JULY 29, 2022) Chart 2: Top traded long+short DLCs by HK underlyings
Disclaimer:
This article is brought to you by Société Générale, Singapore Branch which is regulated by the Monetary Authority of Singapore (MAS). The content of this article does not form part of any offer or invitation to buy or sell any DLCs, and nothing herein should be considered as financial advice or recommendation. Investments in DLCs carry significant risks, the price may rise and fall in value rapidly and holders may lose all of their investment. Any past performance is not indicative of future performance. The DLCs are for specified investment products (SIP) qualified investors only. This advertisement has not been reviewed by the MAS
