SGX Extended Settlement Contracts

Have you thought of investing in the Extended Settlement (ES) contract that SGX has introduced in Feb 2009? Read on to find out how you can familiarise yourself with such contracts and what CashBench advises.

[Photo: Flickr]

Overview:

Extended Settlement (ES) contracts share many similarities with the Contract for Difference (CFD) product available from several brokerages in Singapore. ES contracts are different in that they are offered directly by the Singapore Exchange (SGX) and not at the brokerage level. In Finance lingo, an ES contract is really a Futures contract. If you have ever tried Futures or CFD, you are already familiar with ES contracts. If not, this CashBench entry will be a useful read.

Key Features:

An ES contract is a derivative product, and the value of all derivatives depends on the underlying asset. In this case, the underlying is a stock listed on SGX. SGX has initially chosen 28 securities where ES contracts can be issued on. These are mainly component stocks of the Straits Times Index (STI).

The buzz on ES contracts is the ability for you to short-sell, something that you can’t effectively carry out with stocks unless you go through the hassle of borrowing stocks beforehand. The need for borrowing arises from the need to have the stocks on hand before you can sell them away. Short-selling without borrowing, for a duration of more than one day on the SGX, will get you a nice penalty. With the ES contract, you can take a “short” position and have up to 35 days to buy-in the underlying stock yourself with no need to make any borrowings.

“ES contracts allow you to short-sell, something that you can’t effectively carry out with stocks.”

The exact number of days you have depends on when you take up a “short” position in the ES contract. These contracts are issued on the 25th of every month and expire at the end of the following month. 3 days upon expiry, settlement occurs. If you took a long position, it’s similar to buying stocks. You will pay for the agreed price and the underlying stocks are yours to keep. If you took a short position, you must deliver the underlying stock or face the buying-in penalty mentioned above. Of course, you do not need to wait until the contract expires by closing out your position at any time before the contract expires. Closing out your ES contract position is similar to contra trading in the stock market.

For all the goodies of ES contracts, you need to post a margin collateral before you can buy or sell ES contracts. If you already have a margin-trading account for stocks, you will be fairly familiar with the requirements. Margins are a small portion of the total value of the ES contract and can be as little as 5%. You must deposit a dollar amount with your broker at least equal to the initial margin before you can buy or short-sell ES contracts. If the stock market experience significant price swings and your ES contract loses money beyond the maintenance & variation margins, you will be asked to top-up your account. Don’t have enough cash to top-up? Then you will be forced to close out your ES contract and settle the remaining losses with your broker. Refer to the ES contract guide at the end for more on margins.

CashBench Advice:

This is the most important part of the whole blog entry. ES contracts are not meant to be investment tools on their own. Rather, the main purpose of ES contracts is for risk management and hedging. SGX lists it as the 3rd benefit out of 6 possible benefits. In other words, CashBench generally does not recommend that you buy or sell ES contracts except for managing risks or hedging. Why?

“The primary use of ES contracts is for risk management and hedging, not speculation.”

ES contracts have a contract life of only 35 days. For retail investors like you and me, we are essentially speculating on the price movement of the underlying stock into the future for up to 35 days. Very rarely will anyone be able to make an accurate bet in such a short period consistently. Moreover, as margins are involved, ES contracts are leveraged. This means that your gains or losses will be magnified. Recall that you may only need to pay as little as 5% of the full ES contract value initially. The other 95% is due in about one month’s time unless you close out your ES contract before that. In addition, the ES contract price will change as the underlying stock price changes. Any movements against you will be recorded in a daily process called “mark to market”. With a 5% margin upfront, a 1% movement in the ES contract against you will knock you off by 20%. In other words, by just paying 5% upfront, you have magnified your gains or losses by 20 times. For now, brokers in Singapore require you to put up 10% to 25% of the contract value upfront for a leverage effect of 10 times to 4 times.

For your reference, the SGX ES contract website includes a PDF guide on ES Contracts with more details.

Do you trust bankers to help you?

Would you rather manage your own hard-earned cash or leave the “experts” to do the job for you. CashBench provides a subjective take.

Look at the ad above and you’ll be treated to stunning imagery of how a bank can help to build cities & bridges, and realize dreams for people around the world. Banks, just like any other businesses, are keen to project a positive image where they can do the hard work for you and meet your needs. More than many other companies, banks also need your trust to remain a viable business. Banks can collapse overnight when bad news send their customers queuing up to take out their money. Do you trust your bankers to meet your needs?

Among our many needs is the need for money for a whole lot of things. For those more fortunate, we have some idle money sitting around and can usually do one of a few things. You may continue to let it sit around and do nothing, or use it to invest and hopefully see the money grow into a bigger pile. You can of course just spend it too.

The tricky question to ask when you want to invest your idle cash is this: Do you do it yourself, or leave it to the experts? CashBench shares some tips for your consideration.

1. How much are we talking about here?

If you have at least S$50,000, the doors to personalized advice opens up, if not, there doesn’t seem to be a real choice to start with. Banks and investment advisory firms becomes increasingly more willing to talk to you when you have a larger base to start out with. The richer you are, the more options there are. Banks will typically require you to put up at least S$200,000 in cash and other assets for them to start offering more personalized services. DBS Treasures is one example. However, non-bank outfits may be more accessible. DollarDex for example only require that you start off with S$50,000.

2. Can you afford to spend time keeping up with your investments?

Some of us takes a much higher interest in money matters and actively understand the risk and rewards of the different types of investments available. For example, if you invest in shares of companies, and makes it a point to regularly read and understand the financial health of your invested firms through their annual reports, press releases and also follow general market news, it’s more likely that you will be better off managing your own investments. For others, they may be unable or unwilling to set aside sufficient time to do so and here’s where professional bankers can help.

3. How aware you are of your own financial goals?

To most of us, the more money the better, it’s a given! But, to bankers, they think in terms of mid-term to long-term financial goals and objectives. The clearer you are of what you want, the better they can assist in meeting your goals. Some of us may want to have enough money to fund our children’s university education, others may want to have sufficient cash to meet retirement needs. Having a banker around will help you plan to meet these needs or at least determine how likely you are to achieve them. If you are however unclear of what you need, bankers will probably give some general suggestions that may not be as effective in meeting your real underlying needs.

4. Are you willing to stomach losses?

When you are offered personalised service, the options available are unlikely to be completely safe and guaranteed. Be super cautious when you are being offered products that have a guaranteed profit of X%. Very few investment products are 100% safe and there are often conditions attached. Bankers do not make a living by just offering you fixed deposits and savings accounts. If you will have sleepless nights when your original investment shrinks during market downturns, you should only go to a banker if you know he can offer low-risk or no-risk products.

5. Can you trust your banker?

The ultimate criterion here is the need for trust. Bankers knows it, and you know it deep down too. For bankers to effective, they need to know you well. Right at the start, they will have a lengthy questionnaire asking for personal details, preferences and needs. Good bankers will also continue to keep in touch with you and find out if your needs has changed. If you are not willing to share such details or hold back important information, it’s less likely that you’ll benefit from his services.

FSM Investment Forum: When is the Big Recovery coming?

Fundsupermart.com (FSM) held its first ever investment forum this evening in the NTUC Auditorium at Raffles Place. The forum panel included reps from Soc Gen, UOB Asset Management, Schroders and FSM of course. What were their views, and, how was the event from CashBench’s perspective?

Key Views:

CashBench brings you a first hand account of the key views of the 4 reps at the forum. All of them largely agreed that a recovery in the stock markets should arrive in the third or fourth quarter of this year. They were however quick to point out that investors must remain cautious and have a longer investment horizon. In particular, Mr Albert Tse, Head of Retail Sales from Schroders suggested an investment horizon of 3 years. Those with a shorter timeline of 6 to 12 months can consider bonds because interest rates are expected to remain low in the short term.

In terms of specific sectors and countries, the panel suggested firms dealing in commodities and resources can be good investments. They were still bullish on the emerging markets because there were no serious economic structural issues, unlike in the US. Countries cited included Australia, China, India, Brazil and other countries that has a growing domestic demand for goods and services. For bonds, the forum panelists particularly like investment-grade bonds, and to a lesser extent, high yield bonds.

Snap Shots:

Mr Anthony Joseph Raza, Director of Asset Allocation at UOB Asset Management has a chart that represents the economic boom and bust as a cycle. The chart suggests we are more than halfway through the recession, but Mr Anthony verbally discussed the possibility of a square-shaped recovery: a recovery that can take 7 or 8 years.

Mr Albert Tse also shared that credit recovery is a pre-requisite for equity markets to recover. He described it as the process where companies restructure their balance sheets and focus on cash generation and survival rather than profitability.

Ms Mah Ching Cheng, Head of Research at Fundsupermart.com focused on the more pessimistic numbers. She was however willing to be more specific and suggested the STI can recover to 2100 in the short term. However, Mr Marco Wong, Chief Investment Officer at SG Asset Management also pointed out that markets can “overshoot” or “under-shoot” and like the rest of the other panelists, did not commit to specific numbers for the STI.

CashBench’s Take:

CashBench was glad the forum did not push for any particular products sold by FSM or the reps’ firms. Overall, the forum did at least try to provide some views on when “recovery” will occur. Much of the analysis pushed forth was based on the opinions of the forum panelists and their analysis of “leading indicators”, economic statistics and events from the distant past, essentially the tools of the trade of many analysts. Where there were minor disagreements, it was largely because of the specific indicators or other trends they were focusing on.

It may or may not be surprising that the panel therefore did not focus very much on the specific steps taken by governments to stimulate the global economy or other events that hogged the news recently. For example, there was no mention of the impact of the potential bankruptcy of GM or Chrysler until someone from the floor asked.

CashBench agrees with the FSM panelists that a recovery will occur sooner or later. That is a given. The key is to invest only what you can afford. Mr Marko Wong suggested to invest only if you can still continue to sleep at night and go on holidays. :)

Lastly, even if you do not have a single penny to invest, the FSM investment forum was generous on the refreshments offered. :P