DLCs or Daily Leverage Certificates are a growing interest for investors around the globe. They made their first appearance in Europe in 2012 known at the time as constant leverage products or factor certificates.
Since then, DLCs have become the talk of the town after they are included in the Singapore Exchange (SGX) and people have recognized these certificates as a great way to leverage returns.
But given that DLCs are still relatively new financial investments, there are 5 things an investor should consider before diving in.
1. DLCs Are Short-Term Trading Instruments
As the name suggests, DLCs are exchange-traded financial products which gives a leveraged return based on daily performance of an underlying stock or index. The keyword here is daily performance.
While we are usually customed to the idea of buying and holding stocks for the long term, DLCs work differently in that they are highly leveraged and probably demand more attention.
As such, DLCs are products with features that might be more complex in nature and are only suitable for more investment-savvy people with a high risk tolerance. Furthermore, investors trading DLCs have to be SIP qualified too.
Daily Leverage Certificates currently track the 3 key indices in the Singapore and Hong Kong exchanges:
- MSCI Singapore Index (SIMSCI)
- Hang Seng Index (HSI)
- Hang Seng China Enterprises Index (HSCEI)
And below are the some of the single stocks that Daily Leverage Certificates track:
- …and more
- Tencent (700 HK)
- PingAn (2318 HK)
- Geely Automobile (175 HK)
- Hong Kong Exchange (388 HK)
- …and more
For the full list of DLCs, please check out here.
2. Calculation of the Returns are more Straightforward
Calculating returns of DLCs is easier than you’d think and fuss-free compared to that for warrants. For DLCs, you’re basically taking out the volatility element in warrants completely and are left with a simplistic formula.
The performance of a DLC can be calculated like this:
DLC = Underlying Asset Daily Performance x Leverage – Costs and Fees
Another way to think of this is that your return is influenced only by the change in the daily price of the underlying asset times by the amount you leveraged less any fees and costs.
3. DLCs Values Reset Every Day
DLCs are designed for short-term trading. As the fixed leverage is on a daily basis, there will be a reset at the start of each trading day to reset the exposure back to its intended daily leverage factor, i.e. to be based on the closing level of its reference instrument the day before.
This process of calculation is repeated on each trading day.
Hence, the profits and losses are compounded when if you hold the product for more than 1 day. A simple example is this, if you gain 1% gains on a 5x leverage each day over 5 days, your return will become 27.6% instead of the base 25%.
One should note that DLCs will perform better in a trending market versus a volatile market.
4. Appeal of DLCs
- Fixed leverage of up to 7 times both long and short
- Low capital outlay and maximum loss limited to your capital
- No margin outlay
- Ability to go either long or short to take advantage of market direction
- Transparent pricing and structure
- Traded on the exchange through regular stock brokerage account
In a nutshell, DLCs could be seen as a cheaper alternative to gain exposure to blue chip stocks as compared to buying them directly.
Other Risks of DLCs to take note of
Lastly, beside the known fact of leverage risks where gains/losses are multiplied, there are other associated risks revolving around these instruments that a trader needs to be aware of too. Some of the common ones include:
- Counterparty risk – the risk of the issuer defaulting or partially paying the money you invested.
- Market & Credit risk – level of volatility and liquidity of the underlying product, plus the creditworthiness of the issuer.
- Liquidity risk – Secondary market could be so illiquid that you can’t buy or sell the DLC when you want to.
- Exchange rate risk – there is a chance the DLC is traded in Singapore dollars and yet the underlying reference instrument is denoted in USD, CAD, or another currency.
This type of investment is a powerful tool if you have the skills and expertise to handle it. It’s great for speculative investors who are SIP qualified, can handle larger financial risks, and are into short-term explosive trading.
If you match the criteria above, I encourage you to check out Societe Generale as they have a suite of excellent resources.
As DLCs are listed on SGX and trade like a stock, you do not need to open an account with Societe Generale to trade the product. Simply check with your stock broker, make sure you are SIP-qualified and you are ready to trade DLCs directly.