Category Archives: Legal & Tax

Structured Products and their Importance to Universal Banks’ Profits

The data below is from a large universal bank in Switzerland. It shows that close to a quarter of the entire banks trading profits come from structured products. The fact they make 300% more money with structured products vs equity trading and equity derivatives tells you a lot about margins and how widespread the use of structured products has become. From a client perspective investing in these instruments this can’t be good news regarding the long run accumulation of returns.

This shows that universal banks tend to be milking clients or that they are proposing using a lot of tax-efficient structures, which tends to pose a problem down the road. In the latter case with tax authorities in the former with clients (if they ever get educated to the effects of structured products on long-term wealth creation). trading-profits-universal-banks

Also see my post on equity linked bonds (and the payoff diagram of the equity linked bond in particular) to see how attractive certain structured products are for the investor, and how attractive for the seller (bank).


Equity Linked Bond / Reverse Convertible Bond

Today, reading the F.A.Z, I came across this adequity-linked-bonds for equity linked bonds. These kind of products are interesting as they appeal to people’s need or demand for a high guaranteed percentage return. Everyone knows that current interest rates are close to zero, so you get a lot of regular, even university educated people who are attraced to the high yield shown in the ads (and touted with: “chance for attractive returns, equity bonds with high interest rate on DAX stocks”), but still don’t see the risks associated with them. Their brain has been conditioned to associate a yield and bond price like quote with a safe bond. And who wouldn’t want 7,50 to 8,00% for investing in solid companies such as German automakers. People always need cars.

The role your financial advisor is normally paid for is to recommend good risk-return strategies. Equity linked bonds are rarely such a tool before costs, and even less so after costs. Also they involve you selling short a put. If potential investors saw the phrase: short a put and pocket the premium (for that is what they are doing), they might think twice. The bank guaranteed high nterest rate idea on the other hand hooks the gullible and is therefor the bait. These products get advertised for a simple reason, they allow a higher margin to be pocketed by the firm, in this case Deutsche Bank.

If you look at a payoff diagramm of an equity linked bond payoff-diagram-equity-linked-bond-1you see that your profit is capped and your loss is open ended (apart from interest, i.e. the put premium). Does that sound like a good strategy to pay a bank 100-200bp for? Also note that these products have a time to maturity of 10-14 months. That’s why banks love these products. They simply offer a higher return to them. You are not getting a high enough return as an investor for the risk you’re taking.

In a derivatives lecture my professor pointed this out. One of the young german bankers got pretty aggressive at that point, and very defensive, saying that they were a good deal for the client. The professor said they weren’t. My role as your financial advisor, or of my company, is to make sure you are getting paid for the risks you take and fully aware of the pitfalls.

How Structured Products and Active Funds (Can) Drain Your Wealth – Minimise Capital Appreciation

If you ever wonder why your bank advisor recommends active funds and structured products look no further than below. It shows that an equity fund that’s actively managed will sometimes cost you an extra 60bp (range 0-150bp), which the bank pockets. That’s in addition to transaction fees and custody fees. If we look at structured products we see that it’s not unusual for the bank to take 100bp (one time) in addition to the custody fees and transaction fees. If you have an advisor that creates tailor made structured products you’ll pay up to 200bp (one time) for that (I naively always assumed strategy creation and implementation is part of the service you should expect to be priced in transaction commissions and custody fees. I do either or, never both!). Most structured products also don’t last 5 or 10 years, so the one time fees do impact substantially!

This is the reason why I always recommend clients: let’s buy the underlying or copy the strategy of the active fund (which is easy as transaction costs can be minimised and publication of major fund holdings is often required by regulators). The only rational people who buy these kind of products are ones that can minimise taxes thanks to loopholes or who have discovered an active fund that has an exceptional strategy (rare!).

cost-of-structured-products-active-fundsThe above text is from (sent to customers recently) with color boxes added by me.


Second Homes Initiative and Ermatingen

Here’s some background by Credit Suisse research on the theme Second Homes Initiative (PDF), which is also published on the website of the Swiss Tourism Association:

Ermatingen had 1240 flats according to RFP2000 data of which 84% (1046) are in use all the time, 9% (119) some of the time and 6% (75) none of time.

As of 31.12.2011 the number of flats has increased to 1557 of which 82% (1269) are in use all time. So as of recently Ermatingen was just above the threshold which allows for construction of second homes.

year # in use part in use not in use
2000 1240 1046 119 75
2011 1557 1269 - -

Ermatingen is one of the most advantageous municipalities regarding taxation in the canton of Thurgovia, beaten just by Bottighofen (also near Kreuzlingen). You can use this website of the federal administration to calculate the specific level: Tax Calculation Website by the ESTV (Federal Government of Switzerland).

Importance of the Swiss Vote on 1:12 Salary Range Legislation

Looking at 2009 data published by the US government (IRS) on what the source of the top 400 wealthiest citizens income is, it’s a fair statement to say that salaries don’t account for a big slice of wealth generation:

Source %
Salaries/Wages 8.6
Interest 6.6
Dividends 13
Partnerships and corporations 19.9
Capital gains 45.8

Judging by this there is a large likelihood that any legislation limiting salaries will just lead to a restructuring of incentives/rewards. Example: Capital gains are for the most part not taxed in Switzerland (except at legal entities).

The question now arises though: Will the proposed legislation, which speaks of including non-cash benefits and services as part of salary, be unattractive for shareholders.

Should the legislation make it impossible or difficult for owners, shareholders to generate tax-free or lightly taxed capital gains, the impact of a yes vote would be substantial. Capital is a very mobile commodity that can easily find an alternative and more accomodating tax domicile.

If the 1:12 legislation doesn’t make life for shareholders generating capital gains harder it may help reduce the agency problem and would thus benefit shareholders as a group, as it reduces the incentive for the agent (top management) to milk the company and thus damage the principal.

What happens in SMEs where management (agents) and owners (prinicipal) are identical will be interesting/crucial.

Multinational Corporations & Pleonexia (Tax-Dodging)

Daily-Mail headline today: Google and the £6billion Bermuda tax shelter: Web giant’s haven revealed as Cameron urges global crackdown

The ancient Greeks had a word for it – pleonexia – which means an overreaching desire for more than one’s share. Aristoteles named pleonexia as one of three forms of injustice.

Zuberbühler Associates advises corporate clients against elaborate unethical tax-dodging as the likelihood of a sharp backlash is rising and will endanger the longevity of the accrued wealth and/or brand value.

The founding partner of Zuberbühler Associates bases this policy on his interpretation of the ethics code the CFA programme teaches and personal judgement.

Read more about Googles tax dodging: