Sent to Straits Times on 13 December 2008, but not publised.
I refer to the letter by Mr. Ho Yew Kee entitled “A mistake to overreact” (ST, 13 Dec 2008).
Mr. Ho said, “It would be imprudent for the stewards of town council funds to play it safe and place their reserves in fixed deposits or government bonds, as the returns would not even offset the inflation rate.” He also said, “Corporate bonds provided a yield of 4 to 6 percent, but the corporate have different credit ratings”.
In my view, it would be prudent for the town councils to invest in corporate bonds, provided that the investments are spread over several corporate bonds to reduce the impact of the failure of some of these bonds.
In fact, over 10,000 people were sold the credit linked notes. They were misled into believing that they were investing in a basket of 5 to 8 of the entities, which were financially strong companies or sovereign governments.
They were told that if one entity should fail, they would only lose their invested sum on a proportionate basis. If 1 of 8 entities failed, their loss would be 12.5%.
They were shocked to learn later that they were actually selling credit insurance against the failure of any of these entities. If any single entity failed, their entire principal would be lost. Instead of spreading the risk proportionately over 8 entities, they were taking 8 times of the risk of any single bond!
In addition, their principal was actually invested in a portfolio of 100 to 150 underlying securities, which could comprise of collateralised debt obligations of lower rating. This has additional risk to the investors.
The combined risk of failure of “toxic” credit-linked notes is very high. This explains why many of these notes have failed totally, compared to bond funds.
The stewards of the town councils, who have access to professional advisers, should explain if they were aware about the nature of the credit-linked notes and if the return of 5% is insufficient to match the risk. If the town councils were also misled about the nature of these products, it is their fiduciary duty to take appropriate action to recover their loss.
Several local government bodies in the UK were also misled into investing in similar high-risk products. They took legal action and were able to obtain a court decision to rescind the contracts. I urge our town councils in Singapore to do the same.
Tan Kin Lian
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