Next-generation liability management

Some family investors in Asia are looking beyond simple management of loan, currency and interest rate risks, with an eye on performance generation

Wealthy families in Asia have long turned to banks for help in managing the liabilities of the businesses they own, and using derivatives to lock in interest rates or hedge against movement in foreign exchange rates. 

Some of the more sophisticated family investors in the region are now starting to use structured products and derivatives to generate performance for their portfolios at the same time. 

With these investors, discussions with their banks around liability management are no longer limited to the simple use of FX and interest rate derivatives. Increasingly, they are taking an interest in solutions that leverage other asset classes, such as equities and even commodities. 

Gold gains interest

One approach drawing attention from family offices in the region this year has involved the use of gold as a loan offset, given the precious metal’s surge in value. 

The US dollar appeared to be in freefall from summer 2020, and remains under significant pressure amid near-zero interest rates and the prospect of further fiscal stimulus in the US. 

Needless to say, the greenback’s plight in recent months has had a negative impact on Asian family investors’ loan liabilities denominated in other currencies, such as euro and Japanese yen, says Poh Hsueh Wei, executive director on the Asia-Pacific FX team at UBS Wealth Management Capital Markets.

“We have had some proactive conversations with clients on how they can offset those loans,” says Poh. A big theme this year, she adds, has been to go long on gold. 

The spot price of gold hit a record closing price of $2,069 per ounce on August 6, with investors buying the precious metal as a hedge against the threat of inflation and debasement of fiat currencies, most notably the US dollar. It has since fallen back to $1,888 per ounce on November 17, but remains up by more than 20%.¹

Poh says global family investors have recently been seeking out advice on liability management solutions linked to gold, and holding out for a dip in the price to have the optimum entry point. Clients with a modest- to medium-term bullish view on the asset can, for instance, sell an out-of-the-money gold put option, allowing them to collect premium up front but also offering a chance to buy at a lower price. 

“Cross-departmental collaboration and the close relationship between its investment and private banking arms means UBS can be counted on to deliver such solutions seamlessly”

Poh Hsueh Wei, UBS Wealth Management Capital Markets

UBS has seen interest in gold call warrants – investment products that consist of call options wrapped in structured notes. These products tend to be popular when the price of the underlying asset – in this case gold – is appreciating, as it has been for much of this year, Poh says. 

The structures could include a lookback strike to allow the client to enter at lower levels if there is a dip.

Performance seekers

Some family offices in the region have teams dedicated to managing the cashflows from businesses or individuals or loans, says Poh, and they often have a view on currencies too. These investors are starting to go beyond basic liability management exercises and are looking for outperformance from high-yielding currencies – such as the Indonesian rupiah, Indian rupee and offshore renminbi. 

Lawrence Lee, chief investment officer at Sino Suisse, a Singapore-based external asset manager (EAM), says UBS helps his firm deliver liability management for family office clients, with hedging solutions that use FX derivatives to reduce the cost of loan liabilities. 

“Effective liability management can boost the portfolio’s alpha by cheapening the cost of its liabilities,” he says. 

Sino Suisse also offers clients single-stock and collar financing for its clients. The latter, which involves selling a call option to lower funding costs, helped to protect client portfolios during the Covid-driven selloff at the start of the year, says Lee. “Margin calls were very prevalent in March but, because we were using a lot of collar and single-stock financing, our clients were subject to very little margin financing.”

Leveraged bond portfolios

Another popular strategy, particularly in low-yield environments, is taking out loans to add leverage to bond portfolios, says Eric Pong, founder of Avenue Family Office, a Hong Kong-based EAM. 

Liability management – in particular the close monitoring loan-to-value (LTV) ratios – is especially important for strategies in crisis periods such as that experienced this year, says Pong.

One reason is that different banks have different credit policies. One firm might offer an aggressive LTV for a bond of 70% in normal times, but then rapidly cut the LTV to zero in response to market stress, without even notifying the client, says Pong. That could very quickly lead to a serious margin call.

However, he says UBS has been able to offer a 30% LTV but, to keep it steady in a market crisis, Avenue regularly checks the loan ratio versus the loan value of its portfolio. 

“We also have an internal system to check the collateral value of the investment.”

“Margin calls were very prevalent in March but, because we were using a lot of collar and single-stock financing, our clients were subject to very little margin financing”  

Lawrence Lee, Sino Suisse

Pong adds that, over the past year, Avenue has become much more open to new liability management strategies that involve non-traditional asset classes and structures. 

“These have definitely picked up momentum over the last year or so for us,” he says. “The conversation is no longer so product-specific and siloed.”

Cross-departmental collaboration and the close relationship between its investment and private banking arms means UBS can be counted on to deliver such solutions seamlessly, says Poh. 

As family office investment operations continue to grow in sophistication, this puts the bank in a good position to meet the increasing appetite of these investors for more cross-asset approach to liability management that leverages non-traditional derivatives strategies and structured products.

 

Notes

^{1. Bloomberg, 2020}

 

Family office investing – Special report 2020
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