Making Sense of Common Products Traded on the Exchange

Over the past years, we have seen a myriad of new products in addition to traditional share or stock investments available on the Singapore Exchange (SGX). These include structured warrants, futures contracts, investment trusts and exchange traded funds. This article provides an introduction to these products and provides some insights on factors you should consider before investing.

Share or Stock Investments

First, we will cover share and stock investments traded on the exchange.

When you have successfully subscribed for an initial public offering (IPO) or bought into the shares of a company, you become a part-owner of that company and have a stake in the performance of the company. It is worthwhile for you to find out more about the company's operating model, business environment and its management so as to gain a better understanding of the company's strategic direction, the key challenges and opportunities that the firm faces.

You can gain useful insights through reading the company's prospectus (before-IPO), annual reports, financial statements and corporate announcements. Such information is available on the company's website and on the SGX's website (www.sgx.com ).

You can refer to the Monetary Authority of Singapore (MAS)-SGX Research Incentive Scheme (RIS), http://research.sgx.com/ to obtain analysts' reports on 187 companies listed on the SGX. You can also choose to enroll in courses, such as those organised by the SGX, to learn how to use fundamental and technical analysis to evaluate investment opportunities in companies.

Exchange Traded Funds

Exchange traded funds (ETF) are investment funds listed and traded intraday on a stock exchange like stocks. They aim to track the performance of an index and provide access to a wide variety of markets and asset classes.

ETFs are similar to unit trusts as ETFs allow for diversification and professional management. The management fees for ETFs are lower than those for unit trusts because ETFs employ a passive indexing strategy that aims to allow investors to access capital markets and commodities in an efficient manner.

While the cost of investing in ETFs is generally low, you should also consider the risks involved before investing. These include market risk, where the performance of the ETF is directly affected by the performance of its constituent securities; tracking error, when an ETF may not be able to exactly replicate the performance of the underlying index due to management fees, timing differences and other factors; and foreign exchange risk, when the base currency of the ETF is not in Singapore dollars.

Investment Trusts

There are essentially two types of investment trusts — real estate investment trusts (Reits) and business trusts.

Reits are property funds that invest in real estate assets such as commercial, industrial, retail, hospitality, logistics and residential properties.

Business trusts are business enterprises set up as a trust structure, as opposed to a corporate structure. Unlike Reits, business trusts are usually not focused on real estate assets and are suited for businesses with stable growth and cash flow, such as infrastructure or utilities businesses.

The income of Reits and business trusts are pooled and distributed pro-rata to the unit holders of the trust.

Reits and business trusts may appeal to investors who are looking for investments that are backed by assets and that provide returns mainly in the form of a regular payout rather than capital gains.

However, before you invest, do remember that Reits and business trusts are subject to market fluctuations. The unit price of a Reit or business trust depends on many factors and may go down if its underlying assets drop in value. In addition, the projected dividend distributions may not be achieved if the income of the Reit or business trust is lower than expected.

Structured Warrants

Structured warrants are becoming increasingly popular.

By understanding the risk elements, investors can use structured warrants as an easy and efficient means to express their views and participate in local and regional markets. However, like all other instruments, structured warrants carry risks. You should take time to understand the product features and risks before investing.

Structured warrants are issued by third-party financial institutions (warrant issuers) that give the holder the right, but not an obligation, to buy (call warrant) or sell (put warrant) an underlying asset at a pre-determined exercise price on or before a specified expiry date.

Investors who think that the price of the underlying asset will rise over a specific period of time typically invest in call warrants, while those who think the price of the underlying asset will decrease typically invest in put warrants. Investors may also use put warrants to hedge against the downside risk of their investment holdings.

Structured warrants also offer investors the benefits of leverage. As structured warrants are usually priced at a fraction of the underlying asset, this leverage effect can enable investors to gain exposure to the underlying asset in a cost-efficient manner.

In addition, the potential gain may be unlimited depending on the movements of the underlying asset, while the maximum potential loss is limited to the value of your investment in the structured warrant.

However, investors should note that structured warrants can be very volatile.  A small change in the movements of the underlying asset could result in a much larger movement in the price of the structured warrant.  It is important to note that the value of a warrant decreases over time and becomes worthless if it is not exercised before its specified expiry date. 

It is not advisable for you to invest in structured warrants unless you have a clear understanding of how they work, are able to monitor your investment closely and can withstand volatility in the prices of the structured warrants you hold.

Certificates

Certificates are issuer-led structured financial products that offer investment opportunities based on different market themes and outlooks. Currently, there are two main types of listed certificates – participation and daily lock-in certificates.

Participation certificates are designed to track the performance of the underlying assets. They provide investors easy and efficient access to various assets which could include stocks listed in overseas exchanges, indices covering emerging markets as well unique investment themes (eg. climate change and luxury goods).

Range accrual certificates are yield enhancement products where the investor accumulates a lock-in amount during the term of the certificate if the underlying shares or indices perform within a stipulated range. If the shares or indices do not perform within the stipulated range for any particular day/period, the investor will not accumulate any return on that particular period.  

Investors should take note that the performance of the certificate is dependent on the performance of the underlying assets in relation to the terms of the product. Issuers have dedicated websites offering detailed product guides and information which investors can make use of.

Futures Contracts

Futures contracts are exchange-traded contractual agreements to buy or sell an underlying asset at a pre-determined price on a specified future date. The underlying asset could be a commodity, bond, currency or stock index.

Unlike a structured warrant, there is an obligation on the investor to fulfill the contract at the pre-determined price, either by delivery of the underlying asset or by entering into an offsetting position.

During a bear market, investors with futures contracts can actively participate in the downward movement of a securities market by "shorting" a futures contract or using a futures contract to sell the underlying commodity or instrument, and thus hedge (protect) their share portfolio from a market downturn. Conversely, during a bull market, investors can choose to participate in the broad market movement by buying a futures contract.

To begin trading in futures contracts, the investor is required to place an initial margin with his or her broker. This initial margin represents a fraction of the value of the actual underlying constituent stocks in an index. Trading futures therefore, offers the benefits and risks of gearing. For instance, a small percentage gain in the underlying index may lead to a larger percentage gain for your profit. Conversely, a fall in the price of the underlying index will lead to a larger percentage loss.

As gearing magnifies gains and losses, trading in futures is viewed as being more risky than trading in shares. It is not advisable for you to invest in futures contracts unless you understand how the contracts work and can withstand substantial potential losses should the market move against your expectations.

Conclusion

The various products available on the exchange offer investors a wide array of investment choices and strategies.

Before investing, make it a point to determine your investment objective and investment horizon, understand your risk profile, be aware of how much you can afford to invest and how much losses you can afford to incur.

Make sure you understand how the product works before you invest. Do not invest in anything you do not understand or are not comfortable with.

When in doubt, seek professional advice before making any investment decisions.

This information is provided by the Singapore Exchange (SGX) and the Monetary Authority of Singapore (MAS) as part of the MoneySENSE national financial education programme.