The year started off on a positive note, with equity markets continuing to benefit from the rebound that began in the second half of 2003. Nevertheless, the rally lost momentum after the first quarter, as global markets were caught in a tug-of-war between expectations of rising interest rates and strong fundamentals. Meanwhile, bond markets were dominated by changing expectations about the timing and extent of interest rate hikes. Currency markets had been volatile, while commodity prices remained firm. In particular, oil prices surged to record highs, casting further doubts about the sustainability of a global economic recovery.
With such a backdrop, more conservative investors have sought capital protection and/or yield enhancements (given the still-low interest rate environment), while those with a stronger conviction have looked to profit from their views about particular investments or market volatility. In order to diversify, some also sought out non-traditional asset classes.
Of course, what constitutes the 'best strategies' depends very much on each particular client's needs - strategies that reflect not only the client's risk-return preference, but also his desire to avoid or participate in anticipated market movements. However, bearing that proviso in mind we list below some of the UBS ideas that would have made clients the most money in 2004:
For investors seeking yield enhancement
1. Dual Currency Deposits (DCDs)
Based on a range trading view with a slight positive bias towards the Australian dollar, UBS structured a series of Dual Currency Deposits with knock-out options. These short-term investments were denominated in US dollars and featured enhanced yields. Investments were converted into Australian dollars should the currency fall significantly, but the knock-out feature removed the conversion risk if the Australian dollar appreciated prior to redemption. The DCDs yielded 4% per annum and a further compensatory coupon kick-in in the event of conversion into Australian dollars. Our positive forecast for the Australian dollar was correct and almost all of the DCDs were knocked-out, with the balance redeemed in US dollars.
2. Collateralized Equity-linked Notes (ELNs)
With supply not meeting demand for blue-chip structured notes from some Southeast Asian countries, UBS packaged concentrated equity positions in a number of high-quality companies into Collateralized Equity-linked Notes. Over-collateralized by the underlying equity positions worth a multiple of the face value, the notes significantly reduced risk for investors while providing them with attractive yields. On the flip side of the deal, borrowers obtained financing at an attractive cost.
3. Curve Target Redemption Notes
Risk-averse investors seeking high yields were attracted to Curve Target Redemption Notes which were issued by AA-rated banks and featured principal protection at maturity. Unlike traditional structured notes in which the coupons are calculated based on a formula, the notes featured a fixed total coupon with maturity determined by a formula. The underlying view was for the yield curve to be upward sloping with the result that the steeper the slope, the earlier the notes would be to redeem. The notes are now trading above par with double-digit yields.
For bullish investors with a greater risk appetite
4. Speeders
During a year of market drift, some Speeder notes have provided clients with enhanced returns on selected stocks or indices. While having identical downside to their underlying shares, Speeders typically generate leveraged upside equating to twice any positive return made on the underlying stock over the tenor of the note, subject to a predetermined cap level. Investors who bought Nokia shares to take advantage of its price weakness in August would have made a 23% gain. But if they had bought Speeders on the stock instead, they would be on track to reap the 36% maximum gain (i.e. two x 18% gain on the underlying stock) when the notes expire in May 2005. Similarly, investors in Speeders on ING (expiring in mid-2005) also stand to reap a leveraged return (up to a maximum of 40%) as the result of an 11% gain in ING shares since the Speeders were issued.
5. Laggard ELNs
Laggard ELNs (i.e. ELNs based on the worst performer of a basket of stocks) offer higher yields than single-stock ELNs, especially when the underlying basket contains stocks of higher-than-average volatility. An ELN based on two Japanese stocks, Mizuho Financial and Yamanouchi Pharmaceutical, issued in October 2003, was called one year later as the prices of both shares closed the 12-month period above their initial price levels. Investors in the note received a 41% coupon plus 100% of their invested capital.
For the bond bears
6. Short Treasury Futures Certificates
Short Treasury Futures Certificates have been popular with investors holding cash bonds, as they allow for hedging against further corrections in bond prices, a trend that prevailed in the second half of 2003 and the first quarter of 2004. Clients who bought the Short Treasury Futures Certificate issued by UBS Investment Bank in mid-March 2004 at $10 could have gained around 60% within just two to three months of issue if they sold the Certificate in the secondary market at around $16 when the 10-year Treasury yield rose from 3.7% in March to 4.6-4.8% in May/June.
For investors with a view on commodities
7. Commodity Plays
Worries about supply disruptions, greater than expected demand in some major industrial countries, and the weakening US dollar contributed to a rally in oil. From trough to peak, the West Texas Intermediate (WTI) Cushing Crude Oil Spot price surged by more than 75%. Although oil prices have retreated from their highs in mid-October, the price per barrel of WTI is still up 46% year-to-date. Investors who took the ride on oil would have reaped a fruitful gain by now.
As a less risky method to participate in the rise of commodity prices, UBS structured a certificate with an underlying basket comprised of several commodity indices covering energy and metals. The diversified basket reduced volatility risk relative to direct investment in a specific commodity or a single commodity index and generated an un-leveraged return in excess of 12% combined with low volatility.
For investors looking for diversification
8. Hedge Funds
Year-to-date hedge fund indices have posted low single-digit returns but performance can vary significantly between strategies and managers. Finding a well-positioned manager had the potential to generate superior returns as did a focus on lucrative strategies such as distressed securities - the HFRI Distressed Securities Index was up 11% for the year-to-September. In response, UBS selected a range of in-house and third-party hedge funds to cater to different client requirements including multi-manager multi-strategy, multi-manager single strategy, and single manager funds. Complementary structured products were offered to provide capital guarantee or leveraging.
9. Emerging Market Equities
The majority of emerging market equity markets performed well early in the year but reversed during the second quarter. Year-to-date, performances vary from slight losses to large gains. The UBS Eastern Europe Fund gained 25% but was accompanied by higher volatility than in developed markets. Events such as Yukos in Russia highlight the risks associated with investing in emerging markets but UBS continues to favour a number of emerging markets in the longer term, as fundamentals and valuations remain attractive.
10. Real Estate
In 2004, real estate globally continued to perform well with returns from liquid REIT investments particularly robust. The developed US market, as represented by the streetTRACKS Wilshire REIT Index Fund, is up 19% year-to-date. In post-bubble Japan, the TSE REIT Index gained 28%. Direct real estate investment was even more attractive, particularly in Hong Kong where a long-expected rebound in the sector occurred. Post SARS, residential and commercial properties have appreciated markedly. Prices for grade-A office space is estimated to have risen 30% in the first eight months of 2004.
In addition to these short-term and medium-term investments, there is an increasing trend towards the inclusion of insurance in wealth planning. More insurance companies are entering the high net-worth market, opening up a wider selection to clients. Unit-linked insurance - with or without large death coverage - is favoured by many as a transparent and flexible alternative to existing instruments. In particular, wrap policies that allow for flexible choices of fund managers are gaining popularity.
While the above highlights some of the best investment ideas for the year, some clients prefer to entrust the management of their assets to UBS's professional portfolio managers. The Special Mandate Portfolio (SMP) team provides tailored, diversified portfolio solutions according to the liabilities and/or needs of the clients. Clients define the composition of the portfolio benchmark and leave the active management to the portfolio specialists. In addition to the traditional assets classes, a SMP can also invest in hedge funds, real estate trusts, and private equity (sourced both internally and externally), managed together with an aim to produce optimal risk-adjusted returns.
As investors and investment managers alike search and innovate to find money-making ideas, it is imperative that they do not lose sight of the big picture. The 'best strategy' must sit well within the overall tapestry of the client's portfolio and wealth plan.
Past performance is not an indicator of future performance. In addition, investments discussed may not be suitable for all clients or available in all jurisdictions.
