Nikkei Jump Sees Investors Buy More Complex Notes for Comfort

Convention dictates investors become more uneasy as the structure of their investments gets more complex. In Japan, the opposite may now be the case.

April sales of so-called uridashi bonds tied to two or more equities were the second highest on record for any month according to data compiled by Bloomberg going back to 1997. Most of the securities -- investments targeted at Japanese households -- are linked to the Nikkei 225 Stock Average and another gauge such as the Standard & Poor’s 500 Index.

The Nikkei’s climb above 20,000 for the first time in 15 years last month and the S&P 500’s ascent to a record have increased investor concern the market is overheated and may reverse course. According to Credit Suisse Group AG, the Nikkei gains have seen more people put their money into contracts that start losing money when at least one of the multiple gauges they’re tied to drops below preset levels. Those levels are generally lower than for notes tied to single indexes.

“Many equity-linked structured notes were redeemed earlier due to the rally and distributors have an incentive to propose to their clients to reinvest proceeds into similar products,” Tomoyuki Sasai, the Tokyo-based head of equity derivatives at Credit Suisse’s Japan unit, said by e-mail. If investors in the notes want to keep the same loss-triggering levels as before the equity rally, they “need to take other risks,” such as basing contracts on multiple indexes, he said.

The contracts can also have inbuilt levels that allow investors to make early redemptions once they’re reached. The total risk exposure for investors isn’t too different between notes tied to one equity and multiple ones, Sasai said.

Biggest Issuer

Credit Suisse was the biggest issuer of uridashi bonds tied to multiple stocks in April, selling 38 percent of the $296 million of securities offered, Bloomberg-compiled data show. The total was a 68 percent increase from March, compared with a 32 percent decrease to $1.21 billion for those linked to a single equity.

The largest uridashi tied to multiple shares sold last month was a 12.2 billion yen ($102 million) five-year note issued by Kommuninvest I Sverige AB, a Sweden-based financing company.

The securities pay 5.9 percent annualized for the first quarter, and the same coupon if the levels of the Nikkei 225 and S&P 500 indexes each hold at 80 percent or more compared with their closing price on May 7. If not, they pay 0.1 percent, the data show.

Korea, Taiwan

Japanese investors aren’t alone in venturing into more complex structures. Elsewhere in Asia, including South Korea and Taiwan, people are buying more securities tied to multiple asset classes, known as hybrid structured notes, according to Ryan Chan, the co-head of business development at Societe Generale SA’s cross structuring group for Asia ex-Japan.

“Structures have definitely become more complex,” Hong Kong-based Chan said. “It’s a natural step for people to get more aggressive to get the yield they want in a low-rate environment.”

Investors are adding complexity and moving from so-called single-range accruals to dual-range accruals, which are contracts that accumulate coupon payments during periods when two underlying assets meet preset conditions, he said. The contracts are also starting to combine onshore and offshore market gauges and different asset classes.

Japan’s benchmark 10-year government bond yield was at 0.455 percent on May 13, near a record-low 0.195 percent touched in January.

“By adding more underlyings, the barrier level for each of the conditions can be wider,” said Cyrille Troublaiewitch, the Hong Kong-based head of Citigroup Inc.’s multi asset group for Asia Pacific. “The risk becomes different and even though there are more conditions, some investors may be more comfortable when” it’s less easy to go out of range, he said.

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