BNP PARIBAS WEALTH MANAGEMENT / INVESTOR’S GUIDE

OVERVIEW OF FINANCIAL
INSTRUMENTS AND PRODUCTS
AND THEIR INHERENT RISKS
2
Overview of the categories of risk inherent
in financial instruments and products 5

The different categories of risk 6

Overview on sustainability-related disclosures 10

Investing in deposits and money market instruments 16

Investing in bonds 18

Investing in equities 24

Investing in an Undertaking for Collective Investment (UCI) 28

Investing in funds that use alternative strategies 34

Investing in structured products 42

Investing in private equity 46

Investing in derivatives 52

Investing in warrants 56

Investing in an unlisted real estate fund 60

Investing in commodities 64

Investing in exchange-traded products (ETPs) 68

4
OVERVIEW OF THE CATEGORIES OF RISK INHERENT
IN FINANCIAL INSTRUMENTS AND PRODUCTS
Pursuant to the Markets in Financial Instruments Of course, all the risk elements mentioned should not
Directive 2004/39/EC (MiFID), which entered into force obscure the numerous opportunities offered by the variety of
on 1 November 2007 and was repealed and replaced by available investment instruments and products to increase
Directive 2014/65/EU on markets in financial instruments the value of your assets. Generally speaking, the relationship
(MiFID II), which entered into force on 3 January 2018, between risk (of loss or lack of profits) and expected return
BGL BNP Paribas has written this description of investment is an important concept to guide your choices and build
instruments and products which enables you to assess a portfolio corresponding to your needs and investment
the main characteristics and risks inherent in investing in objective.
certain categories of financial products and instruments.
We recommend that you carefully read the various documents
on each family of investment products that is of relevance
First, the recommended investment universe and the to you, so that you have the required information on each of
investment services them. In this way, we will be better able to support you in
BGL BNP Paribas offers investment advisory and discretionary your investment decisions and advise you, while informing
asset management services (on a non-independent basis) as you as efficiently as possible.
well as the reception and transmission of orders (RTO), the The purpose of these documents is not to exhaustively cover
conditions of which are outlined in the current prospectuses all the categories of financial instruments or all the risks
available on request from your advisor. inherent in investing in said financial instruments.
We offer our recommended investment universe as part of It should be emphasised that a minimum investment duration
our investment advisory services. The following principles which fits your personal investment horizon is assigned to
are used to select and monitor the financial instruments most of the individually considered investment products.
within our recommended investment universe: appropriate This is particularly true for products that have a maturity
and documented selection and monitoring of financial guarantee, even if they offer interim liquidity by allowing you
instruments and issuers; analysis of the risks, complexity to request a redemption with profit before maturity.
and cost of the financial instruments, as well as the
profits they generate; and implementation of a personal Furthermore, we would like to draw your attention to
recommendation process (excluding RTO). the fact that you must carry out your own analysis of the
financial, legal, accounting, fiscal and regulatory aspects
The recommended universe may include financial of each transaction in financial instruments to be able to
instruments issued, placed or distributed by the Bank or determine its advantages and disadvantages, and to assess
other entities with close legal and economic ties to the related risks over the entire investment period.
Bank or the BNP Paribas Group, as well as the financial
instruments of third parties. Finally, we would like to remind you that it is indispensable that
you avoid concentrating your investments, and are committed
The financial instruments to building a portfolio comprising a sufficiently large number
of items and products. Portfolio diversification presents a good
This description gives a general overview of the main opportunity for risk mitigation in many market scenarios.
types of risk you may encounter while investing in the
different families of financial instruments or products
(excluding foreign exchange (FX) spot, physical precious
metals and physical real estate). It supplements various
specific documents that are tailored to each family of
financial instruments or products, entitled “Invest in...” and
comprising three parts: Understand, Evaluate and Select.
These documents are available from your advisor depending
on your potential needs regarding financial knowledge.

5
 THE DIFFERENT CATEGORIES OF RISK
In order to familiarise yourself with a number of 3 Interest rate risk
risks, you will find below the main risks inherent in Movements in interest rates expose the fixed interest rate
investment instruments and products. investor to the risk of loss of capital. Even if the issuer
scrupulously respects the issue terms, just a rise in market
1 Foreign exchange risk interest rates can lead the investor to suffer a loss or miss
out on profit. As a general rule, increases in interest rates
Where an investor buys or sells a currency, or instruments
tend to lower the price of those financial instruments that
denominated in a currency other than the reference currency,
are sensitive to rates to a greater or lesser extent, such as
in addition to the risks inherent in the transaction itself, an
fixed interest bonds and certain structured products, while a
additional risk of gain or loss arises from movements in the
reduction in rates has the opposite effect.
exchange rate used in relation to the reference currency.

4 Inflation risk
2 Risk of changes in net asset values or prices
Inflation can lead to a loss in value of your investments and
The risk of changes in net asset values or prices exists in all
a reduction of purchasing power of the capital invested if
financial markets. The price of a financial instrument is the
the inflation rate exceeds the return yielded by the financial
result of the balance between supply and demand on the
instruments.
market. The price might be subject to unforeseen fluctuations
involving risk of loss. Furthermore, the volatility historically
5 Market liquidity risk
displayed by a particular instrument may change over time,
even without extreme conditions intervening. For the investor, liquidity means the opportunity to sell the
financial instruments that they hold, at any time and at a
Irrational factors, either market factors or factors specific
satisfactory price. In the event of low or insufficient liquidity,
to a particular security, taken individually, can affect overall
the investor may have to sell at a much reduced price or
movements in prices, for example trends, announcements,
even, in extreme cases, be unable to sell part or all of their
opinions or rumours that may lead to unforeseen but sudden
financial assets at any given moment.
and large reductions in price, even though the financial
situation and prospects of the businesses that underlie the
investment involved may not have changed unfavourably.

6
Lack of liquidity may arise from the interplay of supply 8 Economic climate risk
and demand, from characteristics inherent in the financial
Changes in the activity of a market economy always
instrument or from market practices. A contract for purchase
have repercussions on movements in prices of financial
or sale may then not be executed immediately and/or may
instruments and exchange rates. Prices fluctuate according
be executed only partially (partial execution) and/or may be
to the cycle of phases of economic slowdown and recovery.
executed in unfavourable conditions. What is more, higher
The length and extent of the cycles of economic slowdown
transaction costs are likely to apply.
and recovery vary, as do their repercussions on the various
sectors of the economy. Moreover, the economic cycle can
6 Country risk and transfer risk
vary from country to country.
The political and economic climate in certain countries may
become unstable, causing significant or rapid changes in 9 Risk linked to the use of leverage
prices. For example, a foreign debtor may default, it may
become difficult or impossible to convert a currency, assets Leverage that may be attached to a product can have a
may be frozen, or rights may be restricted. In principle, there significant amplifying effect both on the return and on the
is no way to protect against such risks, although country risk associated with the product.
ratings published in the financial press may be of use to
investors in this respect. 10 Risk of finance through borrowing
The purchase of financial instruments by means of borrowing
7 Risk associated with the solvency brings with it additional risk. On the one hand, additional
of the issuer or counterparty guarantees (additional assets as collateral) may be required.
Default by the counterparty or the issuer of financial On the other hand, the loss incurred when prices move
instruments for a financial transaction (or of the settlement/ adversely is liable to be higher than the initial investment.
clearing system on which the instruments are traded) can Fluctuations in prices of pledged financial instruments can
lead to the investor losing all or part of the funds invested. therefore have a negative influence on the investor’s ability
The investor must therefore take into consideration the to repay the loans.
quality of the issuer of the product in which they invest. The It is clearly important to understand that the leveraging
concept of rating (or credit scoring) should in this case very effect produced by buying financial instruments through
much be borne in mind in evaluating this risk, which is liable the means of borrowing results in proportionately greater
to change throughout duration to maturity, in particular for sensitivity to fluctuations in price, and therefore offers the
products with a long maturity. prospect of higher gains, but also at the same time the risk of
higher losses. The risk attaching to such purchases increases
with the rate of leveraging.

7
 11 Additional risks on emerging markets 17 Risk related to the complexity of the product or model
Emerging markets are defined as the markets of countries It should be emphasised that a small number of products
with a medium or low income per capita according to the or instruments within certain of the broad families under
World Bank definition. These markets are in countries which consideration may have special complex characteristics as
may have a certain degree of political instability, and whose a counterpart to the expectation of a corresponding return.
financial markets and economy are still in the process of This complexity may arise from a combination of multiple
growing. These markets may experience high volatility. In risk factors inherent in certain sophisticated products, from
general, the risks listed above may be amplified in these their structure which may yield notably different returns
markets. according to market conditions and movements in their
underlyings throughout the life of the product, or from the
12 Information risk complexity of their legal structure. It is therefore advisable
that investors should carefully analyse the characteristics of
Information risk means the risk of making inopportune
such products to make sure that they are really appropriate
investment choices through lack of information, or through
to their needs.
incomplete or inaccurate information. This may arise from
the investor depending on unreliable sources, having a poor Investment decisions and the management strategy for
understanding of available information, or perhaps from certain managed financial products are based on quantitative
failures in communication. models which may have given good results in the context of
past market conditions, but which may not give the same
13 Operational risks results throughout the lifetime of the product.

When placing an order, the investor must provide certain

18 R
 isk connected with the quality
details needed for its execution to the Bank, such as the
of product management
type of instrument, the type of order, the volume, the date
of execution, etc. The more accurately the order is given, the For investment products that are managed throughout their
lesser the risk of any transmission error. lifetime, particularly for products with a long maturity, the
quality and consistency of the staff in charge of management
15 Risk connected with transaction costs must be considered as one of the major criteria in the
selection of an investment product, particularly to avoid the
BNP Paribas or other national or foreign financial
risk of any deterioration in management when a key person
intermediaries will be involved in the execution of an
leaves.
order, for example as brokers, in which case the fees and
commissions of these entities will be charged to the investor.
19 Sustainability Risk
An investment becomes viable only after these costs have
been covered. An environmental, social or governance event or condition
that, if it occurs, could cause an actual or a potential material
16 Risks specific to certain products negative impact on the value of the investment.

Forward transactions or options can bring special risks and Unmanaged or unmitigated sustainability risks can impact
should be entered into with care by knowledgeable investors the returns of financial products. For instance, should an
with a high risk tolerance. Furthermore, the investor must environmental, social or governance event or condition occur,
have sufficient liquid assets available to meet any margin it could cause an actual or a potential material negative
call that may be made during the life of the product. impact on the value of an investment. The occurrence of
Some products – private equity for example – involve a such event or condition may lead as well to the reshuffle
commitment from the outset for the investor to be able to of a sub-fund investment strategy, including the exclusion
produce funds at short notice throughout the term of the of securities of certain issuers. Specifically, the likely impact
investment (several years) at pre-set times for capital calls, from sustainability risks can affect issuers via a range of
as the initial investment represents only a limited part of mechanisms including:
the total commitment. It is therefore important in this case ■ Lower revenue
that the investor makes such an investment only if they have ■ Higher costs
available funds sufficient to meet all capital calls in full. ■ Damage to, or impairment of, asset value
■ Higher cost of capital and
■ Fines or regulatory risks

Due to the nature of sustainability risks and specific topics

such as climate change, the chance of sustainability risks
impacting the returns of financial products is likely to
increase over longer-term time horizons.

8
9
 OVERVIEW ON SUSTAINABILITY-RELATED DISCLOSURES
Pursuant to Regulation (EU) 2019/2088 (SFDR), which applies 2 Integration of sustainability risks in BGL BNP Paribas’
from 10 March 2021, BGL BNP Paribas makes available investment decision-making process, investment
to you information in particular in relation to its policies on advice and insurance advice
sustainability risks and adverse sustainability impacts as well
as information in relation to financial products. BGL BNP Paribas, as financial advisor and as financial
market participant, takes into account the environmental,
BGL BNP Paribas statements about policies on the integration social and governance risks that could cause an actual or
of sustainability risks and about consideration of the principal a potential material negative impact on the value of the
adverse impacts on sustainability factors in investment advice, financial products it selects or recommends to its clients.
and portfolio management activities and insurance advice.
Through the application of the Group’s sectorial policies
(sector policies), BGL BNP Paribas excludes certain activities,
1 General information
and by doing so takes sustainability risks into account via
BNP Paribas’ mission is to contribute to responsible and the regular risk-return assessment of each covered product.
sustainable growth by financing the economy and advising
The Group took a formal commitment to maintaining an
clients according to the highest ethical standards. The Group’s
open, constructive relationship with its external stakeholders
CSR policy is one of the main components of this approach.
(customers, suppliers, SRI investors, advocacy NGOs, etc.) in
In line with the United Nations’ Sustainable Development
order to achieve three objectives: anticipate change in its
Goals, it is based on four pillars (economic, social, civic and
business lines and improve products and services; optimise
environmental) that reflect its CSR challenges, as well as the
risk management and have a positive impact on society.
bank’s concrete achievements.
For its whole offering of products and services, whether
In 2019, BNP Paribas has published its corporate purpose, a text
sustainable or not, BGL BNP Paribas is aiming to have a
which was prepared by the BNP Paribas Executive Committee,
sustainability rating of its whole recommended universe
based on three texts resulting from a work with many different
with BNP Paribas Wealth Management’s proprietary
employees. These include: the Shared Convictions (Mission and
methodology. This enables BGL BNP Paribas, as financial
Vision), the Code of Conduct and the Engagement Manifesto.
advisor and as financial market participant, to assess the
Moreover, BNP Paribas has been committed for several years level of environmental, social and governance risks from its
by setting itself additional obligations in several sensitive investments as unmanaged or unmitigated sustainability
sectors through: risks can impact the returns of financial products.
■ Financing and investment policies in the following sectors: For instance, should an environmental, social or governance
agriculture, palm oil, defense, nuclear energy, paper pulp, event occur, it could cause a material negative impact on the
coal energy, mining and non-conventional hydrocarbons (for value of an investment. The occurrence of such event may
an updated list of policies, please see group.bnpparibas/en/ lead to the reshuffle of the portfolio strategy, including the
financing-investment-policies). exclusion of securities of certain issuers. In addition, the likely
■ A list of excluded goods and activities such as tobacco, impact from sustainability risks can affect issuers via a range
drift nets, the production of asbestos fibres, products of mechanisms including:
containing PCBs (polychlorinated biphenyls), or the ■ Lower revenue
trading of any species regulated by the CITES convention ■ Higher costs
(Convention on international trade in endangered species ■ Damage to, or impairment of, asset value
of wild fauna and flora) without the necessary authorisation ■ Higher cost of capital and
(group.bnpparibas/en/publications#6). ■ Fines or regulatory risks

■ Restriction lists which define the level of monitoring and

constraint applied to companies which do not fully meet the Due to the nature of sustainability risks and specific topics
Group’s CSR requirements. such as climate change, the chance of sustainability risks
affecting the returns of financial products is likely to increase
In line with the United Nations’ Sustainable Development over longer-term time horizons. For its sustainable offering,
Goals (SDGs), the Group actively participates in designing and BGL BNP Paribas integrates this risk assessment explicitly in
implementing long-term social and environmental solutions its product selection process, next to the standard risk return
within the framework of both the Principles for Responsible assessment.
Investment (PRI) and the Principles for Responsible Banking
(PRB).

10
2.1 Integration of sustainability risks in BGL BNP Paribas’ measurability, data quality and availability, using the
following sources notably:
For Insurance-Based Investment Products (IBIP),
■ External providers: organizations specializing in ESG
BGL BNP Paribas acts as the insurance agent for Cardif Lux
Vie. research.
■ Internal qualitative research from BNP Paribas Asset
Cardif Lux Vie takes into account environmental, social and
governance (ESG) criteria when analysing the investments Management’s ESG analysts assessing ESG performance
made in the general fund. Cardif Lux Vie’s responsible of issuers and reviewing provider data, based on direct
investment policy applies to all asset classes in the portfolio contacts with issuers, academics, institutions, civil society
and also includes the application of the BNP Paribas Group’s research, issuer official publications.
sectoral policies for the asset classes concerned (securities ■ International institutions like Eurostat, OECD, United
held directly). The sector policies govern investment in Nations, Worldbank, International Energy Agency, World
sensitive sectors with environmental and social issues. Health Organization.
Further information on Cardif Lux Vie’s policies on integrating A Stewardship Strategy that includes exercise of voting rights,
sustainability risks into the investment decision-making dialog and proactive individual and collaborative engagement
process, and information regarding Cardif Lux Vie’s SFDR with corporate and other issuers, and engagement with public
classification of products is available on : (cardifluxvie.com) policy makers on sustainability issues.
In addition, BGL BNP Paribas, in its capacity as an insurance A Responsible Business Conduct policy aimed at companies’
intermediary, integrates sustainability risks into the compliance with fundamental rights, in the areas of human
investment decision-making, and investment advisory, and and labour rights, environment protection and anti-
insurance advisory processes. corruption, based on the ten United Nations Global Compact
Principles. It targets to avoid reputational or regulatory risk.
2.2 C
 onsideration by BGL BNP Paribas of the principal
 Forward-looking perspective: BNP Paribas Asset
A
adverse impacts on sustainability factors in
Management has identified three critical pre-conditions
investment advice, insurance advice and portfolio
for a more sustainable and inclusive economic system: an
management activities
energy transition to a low carbon economy; environmental
When selecting and advising financial products, BGL BNP sustainability; and equality and inclusive growth. Together
Paribas takes into account the impact of the underlying these ‘3Es’ represent the pathway to the economic
investment on sustainability factors (environmental, social sustainability that enables investors to safeguard long-term
and employee matters, respect for human rights, anti- returns.
corruption and anti-bribery matters). BGL BNP Paribas
Analysis of asset management companies and of
considers the principal adverse impacts in its investment
recommended funds and ETFs: BGL BNP Paribas leverages
advice, insurance advice and investment decisions through
on the sustainability information gathered by BNP Paribas
the approach detailed hereafter.
Wealth Management from asset managers and based on a
due diligence proprietary questionnaire:
3 T
 he BGL BNP Paribas approach on principal adverse
impacts relies on a range of extra-financial data ■ Funds: questions covering 6 areas, either on the
sources management company and/or the fund regarding ESG
practices and exclusions, voting and engagement policies,
The BNP Paribas Group sectorial policy: BNP Paribas
transparency, sustainability of the asset management
frames investment actions in sensitive sectors, in some
company, sustainable thematic, impact.
cases excluding a number of sectors or companies, see
BNP Paribas Group sector policies developed in cooperation ■ ETFs: questions covering the 6 above-mentioned areas.
with independent experts. On each sector, the Group takes ■ Open-ended Alternative Investment Funds: questions
into consideration a set of mandatory requirements, of covering 7 areas, the 6 above-mentioned areas and the
evaluation criteria and of good industry practices. analysis of the short selling positions of the funds.
The BNP Paribas Asset Management ESG screening on Based on this information, BNP Paribas Wealth Management
issuers of bonds and equities (single lines): BGL BNP Paribas excludes financial instruments from its recommended
can leverage upon BNP Paribas Asset Management’s data universe on ESG criteria, i.e. sector-based exclusions, norm-
and policies specifically focused on sustainability. The based exclusions, exclusion of issuers with the lowest ESG
roadmap developed by BNP Paribas Asset Management is ratings among comparable issuers. Due diligence also
to be found in the Global Sustainability Strategy. Below the identifies how ESG controversies are taken into account in
various elements that make up sustainable investing: the fund’s investment process.
An ESG assessment of issuers is focused on a limited set When made available by the asset managers, BNP Paribas
of robust ESG metrics, selected based on materiality, Wealth Management will enrich its sources with the

11
 indicators in accordance with European regulation updates BNP Paribas Wealth Management’s extra financial rating
and integrate them in its principal adverse impact policy. methodology for each asset class (0 to 10 clovers), based
on the specificities of the financial instruments and issuers.
For Insurance-Based Investment Products (IBIP),
BGL BNP Paribas acts as the insurance agent for Cardif Lux Vie. ESG integration is the first level of consideration for
sustainable development in portfolio management. In
3.1 The BGL BNP Paribas sustainability rating enables addition to traditional financial analysis, Environmental
classification and information on principal adverse (E), Social (S) and corporate Governance (G) practices
impacts become a selection criteria. Considering BNP Paribas Wealth
Management’s rating methodology, financial instruments
Based on these sources, BNP Paribas Wealth Management
with at least 1 clover are being given priority to enter into
establishes, through its proprietary methodology, a
selection.
sustainability rating on all financial instruments of its
recommended universe, be the instrument sustainable or A sustainable mandate considers the extra financial rating
not. The scores vary from 0 to 10 clovers, which enables of a financial instrument as a key prerequisite. Selection is
to classify instruments on a scale based on their level of mainly performed among financial instruments having at
integration of sustainability. least 5 clovers.

BNP Paribas Wealth Management aims at allocating a The sustainability rating is a robust basis allowing to identify
sustainable rating on its whole recommended universe. The principal adverse impacts of a product, and to take them into
scoring enables to compare sustainability of instruments account when classifying the product, or even if relevant, by
within or across asset classes: excluding it, and to inform the client of the above.
■ Equities and bonds: the methodology, based on the Information on sector policies and BNP Paribas Wealth
data feed of BNP Paribas Asset Management, rates the Management sustainable rating methodology is available on
sustainability of the instruments, taking into account the the website bgl.lu.
ESG criteria of the activity and practice of the company, as
well as the ESG criteria of the sector it operates in. 4 Information about the integration of sustainability
■ Funds and ETFs: the proprietary methodology enables the risks into remuneration policies of BGL BNP Paribas
rating of the sustainability of the funds and ETFs. BGL BNP Paribas aims within its Compensation policy at
In the current investment universe, only 30% of issuers are promoting a professional behavior in compliance with the
rated 5 clovers and above, and a lower average rating is standards defined in the BNP Paribas Group Compensation
given to high ESG risk sectors. principles and Code of Conduct.

BGL BNP Paribas leverages on the sustainability rating BNP Paribas’ engagement with society embraces promoting
classification developed by BNP Paribas Wealth Management. sustainability and limiting sustainability risks, i.e.
environmental, social or governance risks. To embark its
The sustainability rating provides a good basis to identify the employees towards those aspirations, BNP Paribas aligns
main negative impacts of each financial instrument. them with these targets by integrating sustainability risks in
As they become available, BGL BNP Paribas will supplement their remuneration policies.
its data sources with the indicators in line with updates The BNP Paribas Group requires for this purpose, within its
to European regulations and will incorporate them into its Compensation principles1), that the variable remuneration
policy on principal adverse impacts. of financial market participants and financial advisors
shall not encourage excessive risk-taking with respect to
3.2 E
SG Guidelines in BGL BNP Paribas Discretionary sustainability risks for investments and financial products
Portfolio Management (DPM) governed by the European SFDR regulation.
On behalf of its clients, DPM seeks to promote sustainable The BNP Paribas Group Code of Conduct promotes
offers. Leveraging on its expertise regarding the analysis of involvement with society, presenting the rules and
ESG (Environmental, Social and Governance) criteria, DPM requirements for employees of the BNP Paribas Group to
aims at implementing a sustainable approach within the uphold its aspirations to be a contributor to responsible
different asset classes and investment vehicles managed and sustainable global development and to have a positive
across the mandates. impact on the wider society. This involvement relies on three
In order to mitigate principal adverse impacts into investment pillars, (i) promoting respect for human rights, (ii) protecting
decisions during the due diligence process, DPM relies on the environment and combating climate change, and (iii)

1)
Compensation principles and Compensation policy for employees.
2)
For more details:
• Promoting respect for human rights: The employees of the BNP Paribas Group are expected to support the respect of Human Rights, considering the direct and indirect impacts of
their activities, and to ensure compliance with the criteria relating to the impact on Human Rights of the company/project when operating in sectors covered by a CSR financing and
investment policy.
• Protecting the environment and combating climate change: the BNP Paribas Group strives to limit any environmental impact indirectly resulting from its banking activities or
directly from its own operations.
• Acting responsibly in public representation: the BNP Paribas Group intends to make a constructive contribution to the democratic process by providing public decision-makers,
in strict compliance with legal and ethical rules, with information to assist their discussions and to help them to take fair and informed decisions. The Group sets a duty to act
12 responsibly with respect to public authorities.
acting responsibly in public representation2). - Smart Fixed Income Higher Income
- Smart Fixed Income High Yield
The “I am Accountable” Charter of BGL BNP Paribas
(Wealth Management) promotes the Group’s social and ■ Smart Vol mandates:
environmental commitments in business activity and - Smart Vol 5
interaction with clients, staff, and stakeholders. - Smart Vol 10
The Compensation policy of BGL BNP Paribas is available on These DPM mandates do not have sustainable investment
the website bgl.lu as an objective, nor do they promote environmental or social
characteristics
5 DPM mandates financial product classification
The investments underlying these DPM mandates products
5.1 Classic mandates do not take into account the EU criteria for environmentally
■ Crystal mandates: sustainable economic activities.
- Short Term Invest USD When selecting investment products, BGL BNP Paribas
- Bonds EUR explicitly takes into account the exclusion of certain activities
- Bonds USD ( see sector policies), and implicitly considers sustainability
- Yield Opportunity EUR risks via the regular risk-return assessment of each covered
- Conservative EUR product.
- Conservative USD
For its whole offering of products and services, whether
- Flexible 30 EUR
sustainable or not, BGL BNP Paribas is aiming to have a
- Alti-Select EUR
sustainability rating of its whole selection universe with
- Alti-Select USD
BNP Paribas Wealth Management’s proprietary methodology
- Balanced EUR
( see BNP Paribas Wealth Management sustainable rating
- Balanced USD
methodology). This enables BGL BNP Paribas, as a financial
- Flexible 60 EUR
market participant, to assess the level of environmental,
- Dynamic EUR
social and governance risks from its investments as
- Flexible 100 EUR
unmanaged or unmitigated sustainability risks can impact
- Equity Premium EUR
the returns of financial products.
- Equity Premium USD
■ Profiled Mandates (classic & funds):
For instance, should an environmental, social or governance
event occur, it could cause a material negative impact on
- Bonds
the value of an investment. The occurrence of such event
- Conservative
may lead to the reshuffle of the portfolio strategy, including
- Balanced
the exclusion of securities of certain issuers. In addition, the
- Dynamic
likely impact from sustainability risks can affect issuers via a
- Equity
range of mechanisms including:
■ Flexible Mandates:
■ Lower revenue
- Flexible 30
■ Higher costs
- Flexible 60
■ Damage to, or impairment of, asset value
- Flexible 100
■ Higher cost of capital and
■ Equity Premium Mandate ■ Fines or regulatory risks

■ Smart Asset Allocation mandates: Due to the nature of sustainability risks and specific topics
- Smart Asset Allocation 10 such as climate change, the chance of sustainability risks
- Smart Asset Allocation 20 affecting the returns of financial products is likely to increase
- Smart Asset Allocation 45 over longer-term time horizons.
- Smart Asset Allocation 55 BGL BNP Paribas integrates this risk assessment explicitly
- Smart Asset Allocation 65 in its product selection process, next to the standard risk
- Smart Asset Allocation 80 return assessment. For equivalent financial risk–return
■ Smart Global Income mandates: products, priority is given to the best ESG players.
- Smart Global Income 1 Information on sector policies and BNP Paribas Wealth
- Smart Global Income 2 Management sustainable rating methodology is available
- Smart Global Income 3 on bgl.lu.
- Smart Global Income 4
■ Smart Fixed Income mandates:
- Smart Fixed Income Core

13
 5.2 SRI mandates (SFDR “Article 8”): range of mechanisms including:

■ Crystal mandates: ■ Lower revenue

■ Higher costs
- Conservative SRI EUR
■ Damage to, or impairment of, asset value
- Balanced SRI EUR
■ Higher cost of capital and
■ Profiled mandates (funds SRI mandates):
■ Fines or regulatory risks
- Conservative
- Balanced Due to the nature of sustainability risks and specific topics
- Dynamic such as climate change, the chance of sustainability risks
affecting the returns of financial products is likely to increase
The Socially Responsible Investments (SRI) mandates do not over longer-term time horizons.
have a sustainable investment as their objective however
they integrate ESG characteristics. Therefore, equity, bond For its sustainable offering, BGL BNP Paribas integrates this
and alternative funds in which the mandates are invested risk assessment explicitly in its product selection process,
will be chosen mostly according to the evaluation of the next to the standard risk return assessment. For equivalent
way they take into account the Environmental, Social and financial risk–return products, priority is given to the best ESG
Governance (ESG) criteria. integration. In addition, the sustainable mandate promotes
ESG criteria and as such selection is mainly performed
While these SRI mandates promote environmental among financial instruments having at least 5 clovers. The
characteristics within the meaning of Article 8 of the SFDR, sustainable mandate targets a minimum weighted scoring
they do not currently commit to investing in any “sustainable average of 5 clovers (ex cash).
investment” within the meaning of the SFDR or the Regulation
(EU) 2020/852 (Taxonomy) on the establishment of a Information on sector policies and BNP Paribas Wealth
framework to facilitate sustainable investment (“Taxonomy Management sustainable rating methodology is available
Regulation”). Accordingly, it should be noted that these on bgl.lu.
SRI mandates do not take into account the EU criteria for
environmentally sustainable economic activities within the 5.3 PMS SICAV
meaning of the Taxonomy Regulation and their portfolio PMS has a majority of sub-funds which do not have sustainable
alignment with such Taxonomy Regulation is not calculated. investment as an objective, nor do they promote environmental
Therefore, the “do not significant harm” principle in relation or social characteristics.
to the Taxonomy Regulation, does not apply to any of the
investments of these SRI mandates. The investments underlying these sub-funds do not take
into account the EU criteria for environmentally sustainable
For sake of clarity SRI refers to its general meaning of economic activities.
investments taking into account extra-financials criteria.
PMS also has a minority of article 8 SFDR sub- funds.
The SRI mandates have not been subjected to external SRI
certification / labeling. These sub-funds do not have a sustainable investment as
their objectives however they do integrate ESG characteristics.
When selecting investment products, BGL BNP Paribas Therefore, equity, bond and alternative funds in which the
explicitly takes into account the exclusion of certain activities sub-funds are invested will be chosen mostly according to the
(see sector policies), and implicitly considers sustainability evaluation of the way they take into account the Environmental,
risks via the regular risk-return assessment of each covered Social and Governance (ESG) criteria in their investment
product. process.
For its whole offering of products and services, whether While these sub-funds promote environmental characteristics
sustainable or not, BGL BNP Paribas is aiming to have a within the meaning of Article 8 of the SFDR, they do not
sustainability rating of its whole selection universe with currently commit to investing in any “sustainable investment”
BNP Paribas Wealth Management’s proprietary methodology within the meaning of the SFDR or the Regulation (EU) 2020/852
(see BNP Paribas Wealth Management sustainable rating (Taxonomy) on the establishment of a framework to facilitate
methodology). This enables BGL BNP Paribas, as a financial sustainable investment (“Taxonomy Regulation”). Accordingly, it
market participant, to assess the level of environmental, should be noted that these sub-funds do not take into account
social and governance risks from its investments as the EU criteria for environmentally sustainable economic
unmanaged or unmitigated sustainability risks can impact activities within the meaning of the Taxonomy Regulation and
the returns of financial products. their portfolio alignment with such Taxonomy Regulation is not
For instance, should an environmental, social or governance calculated. Therefore, the “do not significant harm” principle in
event occur, it could cause a material negative impact on relation to the Taxonomy Regulation, does not apply to any of
the value of an investment. The occurrence of such event the investments of these sub-funds.
may lead to the reshuffle of the portfolio strategy, including It is only possible to subscribe to the PMS sub-funds via the
the exclusion of securities of certain issuers. In addition, the Crystal DPM mandates.
likely impact from sustainability risks can affect issuers via a

14
 6 I nformation about advisory integration of sustainability In the current investment universe, only 30% of issuers are
risks in its investment advice and insurance advice rated 5 clovers and above, and a lower average rating is
given to high ESG risk sectors.
BGL BNP Paribas’ engagement with society has entered a
new era. Our society is constantly and rapidly evolving. Our Results of the assessment of the likely impacts of
future is full of opportunities, but also of risks, principally due sustainability risks on the returns of the financial products.
to rising inequalities and climate change. We firmly believe Share prices of companies with strong sustainability
that collective progress will be achieved only through a practices typically demonstrate less volatility and have
growth that is both sustainable and equitable. fewer large drawdowns. Specifically, the adverse impact
Finance is a key lever for sustainability, and can improve from sustainability risks can affect companies over time via
environmental and social conditions as well as governance a range of mechanisms including:
practices through its financing and investing activities, as ■ Lower revenue
well as adapting its own internal rules. Over the past years, ■ Higher costs
BGL BNP Paribas has restricted its activities in sectors that ■ Damage to, or impairment of, asset value
are considered as being sensitive from an environmental ■ Higher cost of capital and
and/or social point of view (defence & weapons, palm oil, ■ Fines or regulatory risks
paper pulp, tobacco industry, coal-fired energy generation,
unconventional oil & gas, nuclear energy, mining, farming). Due to the nature of sustainability risks and specific topics
When selecting and advising investment products, such as climate change, the chance of sustainability risks
BGL BNP Paribas explicitly takes into account the exclusion impacting the returns of financial products is likely to
of certain activities (see sector policies), and implicitly takes increase over longer-term time horizons.
sustainability risks into account via the regular risk-return BGL BNP Paribas believes that unmanaged or unmitigated
assessment of each covered product. sustainability risks can impact the returns of financial
Moreover BNP Paribas Wealth Management has developed products and has decided to integrate ESG criteria into its
a proprietary sustainability rating approach according to advisory services and develop a selection of impact products
which, after a specific analysis, each financial instrument and solutions, while engaging with clients on sustainability
can be positioned on a sustainability rating scale ranging topics related to their wealth to achieve an impact aligned
from 0 to 10 clovers. with their objectives and mitigate sustainability risks.
Information on sector policies and BNP Paribas Wealth
Management sustainable rating methodology is available
on bgl.lu.

This enables an objective comparison of the level of

sustainability between instruments within a same asset
class as well as across asset classes.
BNP Paribas Wealth Management is aiming to have a
sustainability rating on all of the financial instruments it
recommends to clients (recommended universe) and targets
to progressively cover 100% of this universe.
More specifically, regarding funds, BNP Paribas Wealth
Management assesses the sustainability approach of each
asset management company and the impact achieved via
the financial instruments of each fund.
Up to 130 criteria are assessed, categorized in 6 headings:
■ ESG practices & exclusions
■ Voting & engagement policies
■ Transparency
■ Sustainability of the asset management company
■ Sustainable thematic
■ Impact

15
 INVESTING IN DEPOSITS AND MONEY MARKET INSTRUMENTS
1 What are deposits and money market 1.3 Other money market instruments

instruments and what are their main The short-term capital market (less than a year) offers other
categories of financial instruments negotiable in the short/
characteristics? medium term. These vary by country but are most often
issued by category, particularly by financial institutions
and businesses, and are usually accessible to institutional
1.1 Term deposits
investors.
These are deposits made in a given currency and blocked for
These instruments are issued specifically for durations
a fixed length of time defined in the deposit contract. Except
of a year or less, allowing investors to make short-term
in specific circumstances, the larger the sum invested and
investments. These are known as negotiable debt securities,
the longer the duration of the deposit, the more attractive
which generally include certificates of deposit, commercial
the interest rate will be. The latter will vary according to
paper, Treasury notes and medium-term negotiable bonds.
the specific rates applicable to the currency deposited. You
may request early withdrawal of the capital invested, but In practice, their names vary according to the issuing
will generally be charged interest penalties. economic entity: Treasury bills for State issues, negotiable
certificates of deposit for financial institutions, commercial
1.2 Certificates of deposit paper for businesses.

These are negotiable debt instruments issued by financial Negotiable debt securities are also negotiable before their
institutions corresponding to a deposit made in a given maturity date and interest tends to paid directly on purchase
currency, with a bank or credit institution (for the purposes (precomputed interest).
of comparison, commercial paper is a similar type of
instrument, issued by companies looking for liquidity to 1.4 Money market UCITS
finance their activity). Certificates of deposit can be issued
See page 28 in the chapter “Investing in an Undertaking for
for predefined minimum unit amounts, for a duration varying
Collective Investment (UCI)”.
from one day to one year, the most common maturities being
one to six months or a year. Interest may be paid on maturity
or in advance (precomputed).

16
2 W
 hy invest in deposits and money market 3.4 Foreign exchange risk

instruments? By investing in deposits or money market funds in a currency

other than your reference currency, you may benefit from a
higher rate of return or a relative increase in the value of the
The main advantage of these investments lies in their
currency in question, but in return you run the risk of a capital
availability, their security (provided the issuer has a good
loss if the currency depreciates (relative to your reference
rating), the visibility conferred by their short-term investment
currency).
horizon, and their flexibility as a means of holding capital
earmarked for other investments, meeting the investor’s short-
term investment requirements or contributing to balancing a 3.5 Country risk and transfer risk
diversified portfolio. The political and economic climate in certain countries may
become unstable, causing significant or rapid fluctuations in

3 W
their currencies (making it impossible to exchange the currency
 hat are the main risk components that in question) or restricting transfer rights for non-residents
(exchange control policies, inconvertibility, etc.).
should be considered when investing in the
money markets?
4 W
 hat types of investor should invest in
3.1 Interest rate risk deposits and money market instruments?
This translates as a re-investment risk in that, if interest rates
This type of investment is aimed at:
go down in the short term, investors will see a decrease in the
return on their deposit and money market investments. ■ Either investors who prefer to protect their capital and/
or the liquidity of their investments, rather than take
When a negotiable debt security is unwound before maturity,
advantage of the generally higher returns offered by
there is a risk of capital loss (e.g. if interest rates vary
medium- or long-term investments.
unfavourably), which can result in a reduction in the final
■ Or investors wishing to maintain liquidity whilst awaiting
return for the investor.
other forms of investment, or with specific requirements
(relatively short-term capital withdrawal).
3.2 R
 isk associated with the solvency of the issuer or
counterparty Concerning money market UCIs, you should be aware of their
specific characteristics when making your choice.
These investments involve a risk in that their reliability is
dependent on the continuing solvency of the depository “Dynamic” money market UCIs are more risky than “classic”
institution (for deposits) or the issuer (for certificates of ones because they aim for higher returns and involve a
deposit or other negotiable financial instruments). longer-term investment horizon.

By choosing money market UCITS, this risk can be diversified.

In this case, however, investors must analyse the fund’s
management objectives and portfolio components very Taxation
carefully, as certain dynamic money market products may
contain higher-risk investments. It is important that you seek independent advice about
the taxation applicable to deposits and money market
3.3 Market liquidity risk instruments.

Excluding exceptional circumstances, this type of investment

Your advisor is available to provide any further information you
generally offers good liquidity (deposits can be withdrawn
may require and will assist you in your choices, according to your
early, negotiable debt securities can be sold).
personal needs and investment profile, before any investment
Money market UCIs generally allow day-to-day purchase decisions are made.
or sale and therefore offer good liquidity unless exceptional
circumstances arise.

17
 INVESTING IN BONDS
1 W
 hat is a bond and what are its main It may be fixed or variable, i.e. indexed to money market
rates, inflation, 10-year rates etc. The advantage of fixed-
characteristics? rate bonds is that investors will know exactly, from the day
of purchase, what the yield on their investment will be.
However, this yield will be realised only if the bond is held
1.1 Main characteristics to maturity.
Public sector (States or supranational organisations) and
A bond bears a defined nominal amount (e.g. EUR 1,
private sector (companies, banks, specialised financial
EUR 1,000, EUR 50,000 or EUR 100,000) and duration. At
institutions) economic players have, in the main, access
maturity, the holder recovers the nominal amount of the
to various sources of finance: shareholders’ funds, bank
bond and the final coupon (except if the issuer defaults in
borrowing and the general public (stock market listings,
part or in full).
bond issues).
By way of an example, let us take a bond with a face value
In the specific case of bonds, private and institutional
of EUR 1,000, a duration of seven years and a 4% annual
investors provide capital to the borrower in exchange for
coupon. On the same date each year over seven years,
securities which are called bonds. In actual fact, the investor
this will pay a EUR 40 coupon. At maturity, the investor will
buys the bond straight off the market. A bond is therefore
get back EUR 1,040 euros, which is the nominal value with
a security representing a debt receivable from a private or
the final coupon added to it.
public body. It can be traded either on an organised market
or over the counter (both bought and sold) and remunerates Bonds with an initial or residual duration of over one year
its holder with interest. are traded on the bond market. Transactions can take place
when the bond is issued (primary market) or during the life
This interest is paid in the form of coupons, the dates of
of the bond (secondary market). On the secondary market,
payment of which depend on local practice (yearly usually
unlike stock markets, there is no systematic quotation of
for bonds denominated in euro, half yearly or quarterly for
prices: transactions take place over the counter. Many
those denominated in US dollars).
factors then enter into the equation, which may influence
not only the price but also the liquidity of bonds.

18
1.2 B
 ases on which the prices of traditional issues are 1.3 Different types of bond
quoted
The bond universe is also broad and diversified in respect of
Conventionally, the price of a bond is defined as a percentage the types of bond issued. We can single out, among others,
of its nominal value, which provides a standard method of the following types of bond:
quotation whatever the various nominal amounts may be ■ Fixed rate: the coupon payable at each coupon date is fixed
(and as a result it is possible to compare, for example, the and known from the time of issue.
price of a EUR 50,000 nominal value bond with a EUR 5,000 ■ Floating rate: the coupon is based on short-term rates
one).
(three-month rate) or on long-term rates (constant 10-
A EUR 50,000 nominal value bond quoted at 95% represents year maturity rate); the latter are very sensitive to the
EUR 47,500 (50,000 × 95/100). yield spreads that exist between short-term and long-term
rates at any given moment.
At maturity, however, the amount redeemed is equal to 100%
■ Inflation-linked: these bonds are increasingly being issued
of the nominal amount if there has been no default on the
part of the issuer. by countries in the Eurozone. Both the capital and interest
are indexed to inflation rates. Accordingly, the coupons
The price quoted on the secondary market – for purchase are often fairly low. The price of these bonds is sensitive
or sale – may be more or less than 100% during the life of to movements in real interest rates, that is to say the
the bond, depending on rises or falls in market rates; it is market rates corresponding to the bond duration less a
also necessary to take into account the accrued interest in deduction for expected inflation. This makes them a very
arriving at the value of a particular transaction. This means technical medium for investment and suitable only for
that the buyer routinely pays the seller of the bond the knowledgeable investors.
proportion of the coupon that has already been earned (i.e.
■ Convertible bonds: these bonds include an option for the
the proportion of accrued interest). So, in the particular case
investors to convert them, as and when they wish, into
of buying a bond whose annual coupon is about to be paid,
the issuer’s shares according to a defined procedure
the purchaser will have to pay the seller a very high amount
(conversion price, quotas, etc.). The closer the price of the
of accrued interest, even if they are going to get back that
underlying asset to its exercise price, the more the price
amount very soon. They must therefore ensure that they
of the bond will change in line with that of the underlying
have the necessary funds to pay the whole amount (price
asset. This is why, at a given time t, bonds with an equity
and accrued interest) of the transaction. Any transaction on
profile, others with a fixed income profile and finally a
the secondary market takes effect on a predetermined date
third category of bonds with a mixed profile are defined
(usually the execution date + three business days).
on this market. It is a market with low levels of liquidity
The coupon rate of a bond is defined when it is issued. It (very few new issues each year). It is better to approach
corresponds to the prevailing market risk-free rate (for the this professionals’ market via an undertaking for collective
desired issuance duration) plus a yield pick-up depending investment (UCI).
on the degree of risk of the issuer at the time of issue. In ■ Hybrid bonds: some bonds have characteristics that
addition to the coupon rate, it is possible at any time to are common to both bonds and shares. Ones without a
calculate the yield to maturity of the bond, which allows maturity date are called perpetual bonds. Nevertheless,
different bonds to be compared, since market rates change some of them may be redeemable at the issuer’s discretion
as does the financial standing of the issuer. The actual yield as from some future date (e.g. the tenth year). This option
on a bond at a given time can therefore be very different is within the issuer’s control and may never be used. Such
from its coupon rate. securities are therefore suitable only for knowledgeable
The world of bonds is very broad and diversified, and so is investors. Lastly, during a market crisis, the liquidity of
the method of calculating their coupon, the currencies in these bonds can become very restricted.
which they are denominated, their geographical origin and
the quality of their issuers. As a result, at any one time,
large differences in yields can be observed for bonds of
equivalent duration. It must be borne in mind that high yield
(compared to that of an issuer of the very highest quality for
an equivalent duration) corresponds to increased risk.
In fact, the lower the issuer risk, the lower the yield.

19
 2 W
 hy invest in bonds? 3 What are the main risk components that
should be considered when investing in
In a context where the markets are dominated by uncertainty,
bonds are a form of investment that offer the specific bonds?
advantage of providing both regular interest payments and
the repayment of principal at maturity if the issuer does not
3.1 Interest rate risk
default. However, certain precautions nevertheless need to
be taken to ensure peace of mind with an investment of this The price of a bond can move significantly from the time of
kind: choosing issuers of the very highest quality, favouring its issue to maturity. This price variation is connected with
bonds of a fairly short duration (three to seven years) so as movements in market interest rates. For an identical shift
not to have to sell them before maturity, considering only in rates, the movement in price will generally increase in
fixed rate bonds and ensuring real diversification within the proportion to the length of time left to run to the bond’s
portfolio so as to spread coupon payments throughout the maturity. This is an important constraint for anyone who
year. With this conservative approach, bonds can usually be wants to sell bonds before maturity, as they may make
considered a relatively safe investment. a capital loss if rates rise. Conversely, a knowledgeable
investor who expects a drop in rates can make substantial
It is also essential to consider liquidity, even if there is
gains if they are right. This risk is obviated if the investor
no intention of selling the bonds before maturity: should
keeps the bond to maturity, with the intention of receiving
the need arise, bonds with more than EUR 500 million or
regular interest income. Nevertheless, it will show up in the
equivalent in issue are usually easier to sell. It should be
valuation of the bonds in their portfolio in line with the rate
pointed out that if they are sold before maturity, a capital
of interest at any one time.
loss may occur.
Other approaches consist of buying bonds which return 3.2 R
 isk associated with the solvency of the issuer or
higher yields, or even investing with a view to making capital counterparty
gains (the price of a fixed rate bond rises when interest rates
A bond may not necessarily be redeemed at maturity. In the
fall). This is entering the domain of speculators, and should
event of insolvency, bondholders rank after priority creditors
be left to knowledgeable investors. Taking issuer risk into
(the State and employees). Interim coupons may also not be
account is as necessary as taking interest rate risk into
paid in the event of an issuer default.
account.
Some subordinated bonds rank the investor after holders of
A given market’s default rate (issuer insolvency) is related
traditional bonds: these are called Tier 1 or LT2, and are most
to overall economic conditions and should be watched
often issued by banks. Although the investor has a lower
throughout the duration in parallel with movement in long-
rank, these bonds yield a higher coupon than traditional
term rates connected with the global economic climate.
(senior) bonds.
These two facets of the bond world, which is simultaneously
Issuer insolvency (or default) is quite rare on the bond market,
secure and speculative, will be represented in portfolios
but it should not be overlooked, as the rate of default moves
to varying degrees according to the way in which the
in line with the macroeconomic climate. Consequently,
investor approached this market and according to the
investors should find out about of the quality of the issuer in
general economic and financial climate. Between these two
which they are investing. There is an indicator that exists for
extremes, various intermediate combinations are possible.
this purpose: the rating (or credit score). This gives an idea
Your advisor will be able to help you to make choices based
of the level of risk involved in respect of most bond issuers.
on your objectives.
The main rating agencies are Standard & Poor’s (S&P) and
Moody’s.
The list below ranks ratings in order of risk and also shows
the equivalences between the different rating systems used
by S&P and Moody’s. Credit rating agencies may amend
an issuer’s rating during the life of the bond, in response
to changes in its financial situation. As a general rule, a
downgrading of the rating will cause a reduction in the price
of the bond concerned, especially if it is a steep downgrading
and the market is not expecting it.

20
For long-term borrowing, here is the risk table used by the rating agencies.

Moody’s rating S&P rating Means Category

Aaa AAA Highest quality, lowest risk.

High quality. Very high capacity

Aa AA
to honour financial commitments.

Upper medium quality bonds. Investment grade

A A
Good capacity to honour commitments.

Medium quality. Satisfactory capacity

Baa BBB
to honour commitments.

Speculative. Uncertain capacity

Ba BB
to honour commitments.

B B Low capacity to honour commitments.

High yield
Poor quality. Danger as to payment
Caa CCC
of interest and redemption of the capital.

Highly speculative.
Ca CC
Close to insolvency.

D Default.

WARNING: The meaning of the ratings is given for information purposes only. Situations may vary, including between securities within the
same category.

A bond with a rating of less than BBB- is known as a high yield bond. The risk associated with these issuers is high, as are their coupon
rates. Upward and downward variations in the price of these bonds can be sharp and fast. These speculative instruments are therefore
reserved for investors who accept significant levels of risk. In such a case, investment in a high yield bond fund, managed by professionals
who know how to measure and assess risk as well as how to choose issuers whose financial situation is likely to improve, is more suitable
than a direct investment.

21
 3.3 Country risk and transfer risk 3.7 Additional risks on emerging markets
Since 2011, on top of credit and interest rate risks, there Emerging markets are defined as the markets of countries
has also been country risk, especially with the crisis in the with a medium or low income per capita as defined by the
Eurozone peripheries. In the past, country risk remained World Bank. These markets are in countries which may have
confined to certain emerging countries (prone to political a certain degree of political instability, and whose financial
risks, terrorism risks, etc.). In recent years, the sharp markets and economy are still in the process of growing.
deterioration in the public finances of some Eurozone These markets may experience high volatility. Generally
countries has led to a significant drop in their rating (for some speaking, the risks described above are accentuated on such
into the high yield category), which has spread by contagion markets.
to the financial and non-financial corporate issuers in these
same countries. This situation has taken the form of a sharp 3.8 Special features and risks
rise in bond yields and therefore a sharp decline in the bond
Furthermore, some bonds may contain special features
prices of these issuers.
and risks that warrant special attention. These include the
following types of bond:
3.4 Market liquidity risk
■ Perpetual – When investing in perpetual bonds (i.e. with no
We have already gone through the idea of liquidity in bonds.
maturity), investors should understand that the holdings
If these are resold on the secondary market, liquidity may be
can only be disposed of by sale. Holders who wish to sell
low or non-existent in certain cases (market conditions, type
their bonds may be unable to do so at a price equal to or
of securities). To avoid problems, it is essential to choose
above their purchase price, or at all, if insufficient liquidity
a quality issuer as well as to pay attention to the overall
exists in the market.
amount in issue, which should be equal to or more than
EUR 500 million or the equivalent. Meanwhile, the coupon payments may be deferred or
even suspended subject to the terms and conditions of the
Finally, investors may be very disappointed with transactions issue. Furthermore, as perpetual bonds are often callable,
handled on the primary bond market. For a start, the time investors should be aware of the reinvestment risk.
between the issue being announced and its close may be
■ Subordinated – In the event of an issuer liquidation, holders
too short for retail clients to obtain information and place
an order to purchase. The transaction is therefore settled of these bonds are not priority creditors and therefore can
between institutional investors, who are readily able to get back the principal only after the senior creditors have
mobilise huge amounts of capital (mutual fund managers, been repaid.
pension fund managers, etc.). Moreover, if a retail client ■ Callable – Investors are exposed to reinvestment risk
places an order, it may be cut back, sometimes drastically, when the issuer exercises its right to redeem these bonds
depending on whether the operation has been a success ahead of maturity.
with investors. One alternative is to buy the bond on the Deferred interest – These bonds make it possible to vary
secondary market. or defer interest payments, meaning that investors cannot
be sure how much interest they will receive and when.
3.5 Additional risk of investing in high yield bonds
■ Extendible – These bonds have extendible maturity dates
In addition to the generic risks listed above, investments in and investors do not have a definite repayment schedule.
high yield bonds are subject to risks such as:
■ Convertible– These bonds are convertible to or
Higher credit risk – Since they are typically rated below exchangeable for shares, meaning that investors are
investment grade or are unrated and as such are often exposed to both bond and equity risk.
subject to a higher risk of issuer default. Vulnerability to
Contingent convertible (CoCo) – These bonds have a
economic cycles – During economic downturns, such bonds
conditional write-down or loss absorption feature and may
typically fall more in value than investment grade bonds as
be written off fully or partially or converted to common stock
(i) investors become more risk averse and (ii) default risk
on the occurrence of a trigger event or at the discretion of
rises.
the relevant authority.

3.6 Foreign exchange risk

This is the risk of capital loss due to the fluctuation of the
currency in which the bond is denominated against the
client’s reference currency.

22
■ Loss absorption features – Some bonds issued by Generally, any stock market transaction involves:
financial institutions, though not classified as CoCos with ■ Dealing fees for each bond sale or purchase order, with a
explicit trigger events for loss absorption, may also have minimum dealing charge The amount can vary according
loss absorption features. If, in compliance with rules on to how you place your order, the type of securities, their
the recovery and resolution of credit institutions and origin and the amount of your order.
investment firms, the resolution authority has established ■ Custody fees for holding and managing your securities.
the known or foreseeable bankruptcy of the issuer, it might
decide to take measures affecting the value of its bonds
(bail-in). In this context, the investor assumes the risk of
losing all or part of the amount invested and the interest, Taxation
or may be required to convert their securities into capital
instruments (shares) at the discretion of the regulator. It is important that you seek independent advice about the
taxation applicable to bonds.
■ Market disruption risk – Markets may become disrupted.
Local market disruptions can have a global effect. Market
disruption can adversely affect the performance of the Your advisor is available to provide any further information you
investment. may require and will assist you in your choices, according to your
personal needs and investment profile, before any investment

4 W
decisions are made.

 hat types of investor should invest in

bonds?
The world of bonds is very broad and their behaviour may be
affected by a wide array of factors. Contrary to widespread
beliefs, bond management can be highly technical and
require in-depth knowledge of the characteristics of each
issue and the market environment.
Investments in bonds may therefore be of interest to
investors with very different profiles, ranging from fairly risk
averse to high risk.
Whatever the profile may be, it is very important:
■ To ascertain the exact characteristics of the issue in which
you want to invest.
■ To diversify your portfolio’s bond holdings in terms of
weightings, issuer quality and time to maturity.
■ To take into account your personal investment horizon and
the issue currency.
■ To take advice from your account manager if you decide
to sell bonds before their maturity, and to analyse the
movements in interest rates on the market since purchase
(price movements) so you can determine whether you
have made or lost money.
■ To take into account the fees on bonds. Prior to investing
in convertible bonds, the investor should carefully read
the legal reference documents, namely the prospectus
and the Key Investor Information Document (KIID).
The latter provides you with standardised information
on the main characteristics of the financial product.
If a KIID has been published for your bond, your advisor
will give you this document before every investment.

23
 INVESTING IN EQUITIES
1 W
 hat is a share and what are its main
characteristics?
The main types of share you can hold are:
■ Bearer shares: the majority of shares are held in this
way. The company does not know the identity of its
shareholders. Only your financial intermediary knows
A share is a deed of ownership corresponding to a portion that you are the shareholder; you have to keep yourself
of a company’s capital. By purchasing a share, you become informed by reading the press or consulting the company’s
a shareholder and therefore the owner of a portion of the website.
business in which you have invested. ■ Registered shares: the company knows your identity, which
As a shareholder, you have a certain number of rights: will be recorded in its shareholder register. You will be
■ The right to receive dividends: each shareholder has the informed directly and automatically by the company.
right to a portion of the company’s profits. Every year, at Shares represent a company’s own equity capital (as opposed
the company’s annual general meeting, a decision may be to borrowed capital), which the company does not reimburse
made to distribute a part of the profits to the shareholders (unlike bonds, for example) but may buy back.
in the form of dividends. These dividends are generally
If the company is liquidated, the shareholder has the right to
paid annually but may also be paid quarterly or half-yearly
a division of the company’s assets, after the company’s bond
as interim dividends. The AGM may also vote to reinvest
and bank creditors have been paid.
the profits in order to finance the company’s development.
In this case, no dividend will be paid to the shareholders. You should be aware of whether you are operating on a
■ The right to vote at ordinary and extraordinary general regulated market, which has specific protection measures,
meetings. or over the counter.
■ The right to be kept informed: this gives you access to Shares can be traded in either of these venues.
certain information about the company. As a shareholder,
the company is obliged to inform you about events which
affect the business, in particular any changes in ownership
(acquisitions, sales) and any significant events affecting its
development prospects. The annual financial statements
for the last three financial years, as well as the latest
annual report, must also be made available to you.

24
Stock exchanges are regulated by local market authorities.
Among other things, these regulations govern:
2 Why invest in shares?
■ Transaction rules (e.g. methods for matching buy and sell
Stock markets give you scope for a wide range of investment
orders).
opportunities. As a general rule, investing in shares enables
■ Measures to protect the various participants (for example, you to take advantage of opportunities arising from various
in the European Economic Area, protection of retail industries and sectors around the world and to benefit in
investors through the Markets in Financial Instruments turn from capital gains as well as dividend income.
Directive, or MiFID).
When you become a shareholder, you benefit from the
Each local authority can also choose whether to recognise company’s profits, both:
a foreign stock exchange. This implies for example that ■ Directly, in the case of the profits earned by the company
investors’ level of protection may not be guaranteed to the
during its last financial year. You receive a dividend
same extent from one financial centre to another. An investor
periodically, provided the AGM votes to pay one.
could, for instance, be less protected on a specific emerging
■ Indirectly, in the form of capital gains resulting from the
market than on a developed country’s market.
market’s perception of the potential development of the
Legislators will additionally regulate access to public company’s profits over the coming financial years (the
savings and admission to trading, setting out the terms anticipated growth in future profits affects the share price).
and conditions of listing (minimum number of shares to be
In certain circumstances, the potential for capital gains can
issued, disclosure requirements, etc.) and the various levels
be accentuated: in the case of a takeover bid on the stock, for
of publication requirements imposed on listed companies
example. In return for these opportunities, before investing
(results, corporate actions, etc.).
in any shares, you should be aware that several elements
It should be also remembered that each country’s legislation, influence changes in their price and that specific risk factors
as applied to financial markets, has its own definition of the apply to this type of security.
concept of a regulated market. A regulated market according

3 W
 hat are the risks to be taken into account
to a given country’s legislation is not necessarily recognised

when investing in shares?

as regulated by foreign legislation.
For example, in terms of European legislation, all markets
within the European Economic Area (EEA) can claim the
status of a regulated market. Foreign markets outside the EEA
The risks attached to shares are twofold in that they are
can take steps to obtain regulated market status to enable
linked either to the issuing company itself or to the behaviour
European investors to access their operations more easily.
of the markets as a whole. A certain number of elements will
In order to do this, they are subject to certain obligations
therefore influence a share price:
and procedures. OTC markets are any markets which have
not been granted the status of regulated market. Within this ■ The interplay of supply and demand for the shares on the
category, some markets are more regulated and organised market. This will determine the volatility (i.e. the potential
than others. for upward or downward movement) of the share price
based on market factors that may or may not be objective.
Finally, with regard to companies issuing stocks on foreign
markets, there are certain specific types of security to ■ The valuation of the company and anticipated future profits:
mention: a share’s value changes according to the company’s present
■ American Depositary Receipts (ADRs): a certificate and future economic activity. The share value will also
issued by a US bank against shares held in custody and depend on how the company manages and communicates
representing shares issued by non-US companies. ADRs about external factors: the local and international
are denominated in US dollars with an underlying security economic climate, geopolitical developments, changes in
deposited locally at a US financial institution. interest rates, exchange rates, commodities, etc.
■ Global Depositary Receipts (GDRs): global certificates In addition to the general risks inherent to all investment
representing foreign shares in the same way as ADRs, products, the following risks apply to shares:
denominated in an international currency (often USD) and
issued by a depositary (often a British or Luxembourg bank) 3.1 R
 isk associated with the solvency of the issuer or
against foreign shares that are deposited with a local bank counterparty
in the same country as the issuer.
By purchasing shares, the investor becomes a joint owner of
GDRs can provide access to local capital markets, particularly the issuing company, participating in its development as well
if such access is restricted by administrative regulations or as the opportunities and risks arising from that development.
technical difficulties. A company may suffer financial losses, the worst-case scenario
being an issuing company going bankrupt, which could result
in the shareholder losing all the money they invested.

25
 3.2 Information risk An independent investor must take great care when operating
on an unregulated market. The securities on these markets
The information available on the company or the quality of
are aimed at investors who have, through their trading,
the information provided by the company itself might not
acquired an extensive understanding of this type of security
be of a standard that would provide you with appropriate
and the ability to follow its development on a day-to-day
decision-making data in order to properly assess the stock’s
basis. Such investors must accept the risk of strong price
financial prospects.
fluctuations and an absence of liquidity.

3.3 Risk of changes in net asset values or prices In view of their high risk level, emerging market shares are
reserved for experienced investors, who should invest only a
The greater the volatility, the higher the risk (on the other portion of their assets in these markets.
hand, the potential for financial gain can be much larger).

4 W
 hat you need to know before investing in
Share prices can be subject to unexpected and sometimes

equities
abrupt fluctuations, resulting in capital losses on your
investment. Price increases and decreases alternate over
the short, medium or long term, and it is impossible to define
the duration of these cycles. Price changes result both from
factors specific to the market as a whole and from factors Before deciding to buy or sell shares, you should have at your
specific to the security itself. disposal all the elements required to analyse the issuing
company, in particular:
■ The company’s situation: its earnings, prospects, sector of
3.4 Market liquidity risk
activity, the changes in its share price and volumes within
The size of the issuing company can influence the volatility
its market sector, its competitors, its market share at home
of its share price: a small or medium-sized company (with
and abroad, its solvency (credit rating), its sensitivity to
small or mid-sized market capitalisation) is likely to offer
changes in interest rates, exchange rates and commodity
less share liquidity and greater price volatility.
prices (hedging tools), its geopolitical exposure and more
Furthermore, it is generally advisable to be careful about generally the economic environment.
any interventions on thin or low-liquidity markets (markets ■ The company’s capital: the main shareholders (or the
trading small stocks with large potential for growth, narrow absence of a reference shareholder), the portion of its
exchanges, etc.). capital available on the market (floating capital), its
market capitalisation, its inclusion in or exclusion from a
3.5 Risk of no dividends reference index (geographical or by market sector), etc.
A share’s dividend is determined according to the profits ■ The share itself: the price change over different periods
earned by the issuing company. Thus, if profits are low or (absolute change and change relative to its sector or
losses are incurred, it is possible that the dividend will be geographical area), the highest and lowest prices reached,
reduced or that no dividend will be distributed at all. the price volatility, the level of certain market ratios (price-
to-earnings ratio, or PER, dividend yield, etc.), the market
3.6 Foreign exchange risk opinion of the share (consensus), the share’s liquidity
(volumes traded), etc.
For securities which are not traded in your reference
currency, the exchange risk must be taken into account. This Some of this information will be available in the company’s
would be the case for a euro investor investing in American annual report, on its website or in the specialised press. It
shares (quoted in US dollars), for example. will allow you to select the share which best corresponds to
the investment you wish to make.
3.7 Additional risks on emerging markets ■ Remember to diversify your portfolio in order to limit

Anyone investing in shares on emerging markets must be risk. You should balance your investment capital between
aware of the specific rules which apply to them, particularly several stocks. It is not advisable to concentrate too great
when access to information is more difficult, making it harder a portion of your portfolio on one single position. It is,
to understand these markets and keep track of securities. however, wise to diversify positions over different market
sectors (cyclical stocks and defensive securities) and
You should be aware of whether you are operating on a different countries and areas (the geopolitical and foreign
regulated market, which has specific protection measures, exchange risks must then be taken into consideration).
or a free market.
■ Monitor the changes to your portfolio regularly and pay
careful attention to any information published by the
companies whose shares you hold (turnover, earnings,
corporate actions, acquisitions, etc.).

26
 5 W
 hat types of investor should invest in
shares?
■ Buying shares is reserved for investors with a long-term
investment horizon (in general, at least five years).
■ Beyond stock picking and monitoring, from a more global
stock allocation and portfolio construction perspective, you
might take different approaches tailored to your personal Before investing in any shares, you should have at your
needs or interest in one specific market or another, for disposal all the decision-making elements provided by
example: an economic, financial and market analysis of the issuing
company and of the relevant stock markets and economies.
- Seeking to invest on several markets worldwide for the
purposes of international diversification. All these factors make shares a difficult product to evaluate
- Conversely, sticking mainly to your home market. and therefore a high-risk investment. Financial gains are not
-
Seeking to benefit from the buoyancy of certain guaranteed and it is possible to lose a significant part of the
developing or emerging markets. capital invested, even in the very short term.
- Adopting approaches that are thematic (commodities, However, in general, shares traditionally constitute one of
etc.) or based on different industries or management the most efficient long-term investments.
styles (growth or value stocks, high-yield stocks, etc.).
In conclusion, investing in shares is for experienced investors
Although we do not intend to deal here with portfolio with a long-term investment horizon.
management principles, we must stress the fact that,

Taxation
whatever your personal approach to equity markets, you
can participate in certain markets in a secure way indirectly
by investing through vehicles that offer, in particular,
diversification, monitoring or specific access. Such vehicles
It is important that you seek independent advice about the
could be mutual funds or UCITS, exchange traded funds
taxation applicable to shares.
(ETFs), or structured products (index-linked, indexed to a
basket of stocks or indices, etc.).
Your advisor is available to provide any further information you
These vehicles may prove particularly useful as a means of
may require and will assist you in your choices, according to your
investing in emerging or commodities markets, for example.
personal needs and investment profile, before any investment
decisions are made.

27
 INVESTING IN AN UNDERTAKING
FOR COLLECTIVE INVESTMENT (UCI)
1 W
 hat is a UCI and what are its main
characteristics?
■ FCPs: An FCP (Fonds Commun de Placement) is a unit-
issuing mutual fund comprising a jointly owned portfolio
of securities. The unit bearer does not benefit from any of
the rights conferred on a shareholder.
An undertaking for collective investment (UCI), or mutual
More generally, different investment vehicles coexist
fund, is a legal vehicle that holds and manages a portfolio
worldwide and can be classified according to criteria
of financial or non-financial assets on the common behalf of
pertaining to their legal or corporate structure:
multiple investors, in accordance with a predefined policy
and set of goals. UCIs are managed by financial sector FCP (France, Luxembourg), Investmentfonds (Germany),
professionals authorised by the local financial regulator unit trusts (UK), SICAV (France, Belgium, Luxembourg, Italy),
(usually referred to as portfolio management companies). SIMCAV, FIAMM and FIM (Spain), etc.

When you buy a UCI, you indirectly hold a fraction of this Lastly, an investor may be prompted to subscribe to what are
portfolio, in the form of either units (for FCPs – see below) or known as feeder funds. This happens when there is a specific
shares (for SICAVs – see below). master fund/feeder fund structure, in which both funds
are distinct legal entities with their own decision-making
There are two main categories of UCI, which operate
bodies. A master fund is a fund where the underlying assets,
identically from a financial point of view but have different
whatever their nature, are grouped together and managed
structures and thus methods of legal functioning:
as a whole. The object of the related feeder fund or funds is
■ SICAVs: A SICAV (Société d’Investissement à Capital
to subscribe exclusively to the units of the master fund and
Variable) is an investment company with variable capital therefore offer its/their own investors access to the master
that benefits from a legal regime very similar to that of fund.
a public limited company. It issues shares as and when
subscribers apply to invest. When you buy shares in a
SICAV, you become a shareholder and therefore enjoy the
rights conferred on all shareholders (e.g. the right to vote
at general meetings).

28
Undertakings for collective investment, whatever their 1.1 A few definitions
nature, are managed by specialists and offer an opportunity
Distribution share class: income will be paid out in the form
to invest without being an expert in the financial markets
of dividends.
and to benefit from the expertise of professionals who will do
everything in their power to achieve the UCI’s management Accumulation share class: income will be reinvested in the
objective. The latter is specified in the reference information portfolio and will increase the net asset value of the UCI.
documents, generally known as the prospectus and the Key
Capital gains/losses: these correspond to the difference
Investor Information Document (KIID).
between the redemption price per unit of the UCI and its
The UCI’s legal documents, as well as national regulations, subscription price.
define specific investment ratios imposed on the portfolio
Benchmark: a manager will generally seek to outperform a
management company handling its financial management,
market index or a composite of several indices over a given
according to the categories of financial securities held in the
period.
UCI.
Absolute return: unlike comparison to an index, the manager
In general, most UCIs are subject to the approval of a
will seek to preserve the capital and generate a positive
regulator based in the legal domicile of the UCI. They can
return regardless of the market configuration.
then be authorised for sale in different countries after
A UCI’s net asset value is the price of the mutual fund unit or
approval by the local financial regulatory authority.
SICAV share, excluding entry or exit fees.
Within the European Union, a growing number of European
UCIs and asset management companies comply with the 1.2 Categories
European UCITS regulatory format which aims to improve
There is no official international system of UCI categorisation.
investor protection through rules governing diversification,
However, depending upon its management objective, a UCI
concentration and liquidity, and which gives almost
may specialise in:
automatic access to the European passport. For example, a
■ An asset class (equities, bonds, money markets, etc.)
UCI authorised in its country of origin (e.g. Luxembourg) can
■ A business sector
offer its units in other Member States of the European Union
by asking its own regulatory authority for entitlement to the ■ A region

European passport for other Member States. ■ A management style

■ A market capitalisation size
A description of UCITS-compliant undertakings for collective
investment that use alternative strategies (Newcits) can be Conversely, some funds diversify into a variety of assets in
found in the section “Investing in alternative strategies”. pursuit of a specific theme.

29
 Management type on the change in asset value over the holding period. The
In addition, the UCI may offer a guarantee or a promise of a manager’s goal is to outperform the benchmark while
minimum return, notably through the use of a formula, or be staying more or less correlated to it.
actively or passively managed. Furthermore, for several years there has been a tendency
In the case of active management, the fund manager can to compile different underlying assets within a single
make investment decisions with the aim of: UCI in order to boost returns. One example of this is the
■ Protecting capital first and foremost. This category includes balanced UCI, which combines exposure to a variety of
money market UCIs. volatile and risky assets in order to make the risk-return
■ Outperforming a benchmark index or a composite of profile more attractive than the fixed allocation of two
multiple indices by deviating to a greater or lesser extent UCIs with a “pure” financial management approach.
from the composition of the benchmark or indices. This is
a conventional, long-only UCI. This type of management
consists of buying an asset – for example, a stock or a bond
– such that the investment performance depends entirely

30
 If the management company so desires, index funds can be
traded on an exchange in the same way as a stock. Funds in
this distinct category are called trackers or exchange-traded
funds (ETFs). While passively replicating the performance
of an index, trackers are continuously quoted on the stock
exchange and can be bought and sold like a share. As a
result, liquidity and size are key criteria.
UCI type
A UCI can be open-ended (which is usually the case) or
closed-ended:
■ Open-ended funds: there is a pre-determined number
neither of shares/units nor, for that reason, of investors.
The UCI may issue new shares/units or redeem those it
has already issued. With respect to investors, the UCI is
required to redeem the shares/units at its own expense, at
the agreed redemption price and in accordance with the
prospectus and/or subscription form.
■ Closed-ended funds: issuance is limited to a set number
of shares/units, or subscription may be limited to a set
period. This category includes UCIs that offer a specific
strategy for a certain period (underlying assets are dated
bonds). Unlike an open-ended fund, a closed-ended UCI is
not required to redeem shares/units. These may therefore
be sold only to third parties or, if applicable, on the stock
market. The selling price depends on supply and demand.

2 Why invest in a UCI?

Diversification of the underlying investments implemented
by the UCI can limit the risk of loss and may increase the
likelihood of making gains. UCIs can also spread risk by using
a diversified portfolio that is less exposed to a drop in the
value of one of the holdings.
For all its investments, the UCI generally benefits from more
favourable conditions (notably in terms of costs) than those
available to individuals investing directly in the same assets.
Since investments are pooled by a single asset manager –
an expert in the field – the latter has access to a range of
human and technical resources (research teams, computer
■ Generating absolute returns. This kind of UCI, known as simulations, sophisticated analysis, etc.) which help it
an absolute return fund, seeks to consistently generate improve the quality of its decision-making and thus allow all
positive performance. This category includes flexible funds the unit bearers or shareholders to benefit from improved
and “Newcits”, which comply with the European UCITS performance.
directive and are managed using alternative strategies.
Most of the time, UCIs offer a controlled level of legal risk,
Hedge funds also fall into this final category but are not with national and international regulations tending to
subject to the same strict regulations. Descriptions of provide a strong framework for the functioning of this type of
“Newcits” and hedge funds can be found in the section financial instrument. Furthermore, they are subject to first-
entitled “Investing in funds that use alternative strategies”. level controls carried out by the management companies
In the case of passive management, the manager aims to themselves, as well as controls performed by the designated
replicate a market index and the UCIs are usually known as fund depository, the designated auditor and the national
index funds. regulatory authority which, in most cases, has expressly
approved the UCI.

31
 In general, there is a broad choice of specialised or diversified 3.3 Liquidity risk
UCIs offering sufficient liquidity to allow for easy switches
Investors should be aware of the liquidity offered by the UCI
between funds or even within a fund, for those which are
in terms of the frequency of its net asset value calculations
made up of sub-funds. This makes it easy to take advantage
and any redemption conditions. In addition, in certain
of a wide range of investment opportunities. A UCI may
exceptional circumstances, the net asset value calculation
allow a client to be present in a given geographic area (an
may be temporarily suspended, and so likewise any
emerging market, in particular) or sector which would be
subscriptions/redemptions.
more difficult to access through individual securities and
without special expertise. The volume of assets under management held in the fund
should also be taken into account.

3 W
 hat are the main risk components
that should be considered when
3.4 Operational risks

investing in UCIs?
The investor should check the operational risks involved
in the management process and the controls implemented
by the management company to mitigate these risks,
particularly when executing subscriptions/redemptions.
The degree of risk varies according to the UCI’s management
objective. In all cases, a UCI primarily exposes the unit bearer
3.5 R
 isk connected with the quality of product
or shareholder to the following risks:
management

3.1 Risk of price changes The quality of the fund manager is an important consideration,
particularly as regards their management quality, experience
These are market risks related to changes in the index and reputation.
underlying each UCI. The net asset value of the UCI will
follow, fairly closely, rises and falls in the markets of the A UCI may not perform in line with its objectives, and
financial instruments and currencies held in the portfolio. investors may not get back all of their initial capital (less
For (guaranteed or protected) formula funds, we would subscription fees). Unless specified otherwise, absolute
encourage you to carefully analyse the various possible return funds have no capital preservation guarantee.
market scenarios. Lastly, the volume of assets under management held in the
Units/shares in UCIs are subject to the risk of a fall in their fund should also be taken into account.

4 W
 hat you need to know before
price; all other things being equal, such decreases reflect a
fall in the corresponding value of the securities or currencies

investing in a UCI
that make up the assets of the UCI. Theoretically, the greater
the diversity of investments, the lower the risk of capital
loss. Conversely, the risk is higher when the UCI holds more
specialised and less diverse investments. Investors should
therefore be aware of the general and specific risks related 1 B
 e sure to read the legal reference documents, i.e. the
to their investment strategy and to the financial instruments prospectus and the KIID, attentively. The KIID will provide
and currencies held in the UCI. you with standardised information about the UCI, and
the prospectus with exhaustive information. In these
documents, you will find information on, among other
3.2 R
 isk connected with the quality of product
things, how the SICAV or FCP operates, its financial
management
characteristics, its costs, the list of people involved in its
The management objective may be only partially achieved activity and its inherent risks.
if the UCI is not an index fund. The quality of the fund These documents can be obtained in full on request
manager is an important consideration. The capital losses and are often available on the management company’s
or gains made by a manager will depend partly on the website.
quality of their decisions, and therefore on whether their
investment predictions come true over time, and partly on 2 U
 nless stated otherwise, and except for guaranteed-
their reputation and level of experience. capital UCIs, there is no guarantee for capital invested.
Some UCIs, particularly those composed essentially of
shares, are aimed at investors looking for a high level
of performance linked to the changes in predetermined
financial indicators, in return for a high level of risk.
3 T
 he most important risk criterion to consider is the UCI’s
volatility. This risk indicator measures the size of previous
price variations. High volatility levels mean that the UCI
could see significant upward or downward fluctuations.

32
4 A
 wards and ratings attributed by various organisations
will allow you to evaluate the quality of the UCI’s
Taxation
management. Although past performance is no indicator
It is important that you seek independent advice about the
of future results, and comparisons between UCIs are not
taxation applicable to UCIs.
always consistent, it will help you in your choice.
5 W
 hen deciding to invest, you must take into account the
Your advisor is available to provide any further information you
investment horizon recommended or indicated in the UCI
may require, to supply you with BNP Paribas’ UCI investment
documentation. It is generally five years or more for an
recommendations, and to assist you in your choices, according to
equity fund, three years for a UCI composed mainly of your personal needs and investment profile, before any investment
bonds, and between one day and one year for a money decisions are made.
market fund.
For formula (or structured) funds (which may be
guaranteed or protected), or those which have a fixed
maturity date, the shareholder or unitholder must not
need to recover their invested capital before maturity.
Investors should therefore ensure that they have sufficient
financial assets to enable them to not be forced to request
a redemption before the maturity date. The capital
guarantee or protection is valid only at maturity.
6 C
 onditions of investment in a UCI: frequency of net asset
value publications, the reference (or denomination)
currency of the fund, the total size of the fund, exit
conditions, etc.
7 Net asset value, how it is used:
Net asset values are calculated daily, weekly or sometimes
less frequently, depending on the underlying assets.
An individual sub-fund within a UCI may be subject to
valuation in several distinct denomination currencies.
The net asset value used as a benchmark for determining
the purchase or redemption price will be:
■ Either the last known net asset value, called a
“known price”.
■ Or the next net asset value to be calculated, called an
“unknown price”.
To find out the net asset value at which the subscription
or redemption will be executed, you must consult the
UCI’s prospectus.
When placing any order (subscription or redemption), it
is advisable to check the deadline by which it must be
submitted for it to be executed at the benchmark net
asset value indicated in the prospectus.

33
 INVESTING IN FUNDS THAT USE ALTERNATIVE STRATEGIES
1 W
 hat is an alternative strategy and what
are its main characteristics?
Global macro strategies
Macro managers establish their investment strategy on the
basis of an analysis of global macroeconomic trends, which
are then translated into directional investments through
“Alternative” management differs from traditional a wide range of instruments: equities, bonds, currencies,
management (long-only equities, long-only bonds, etc.) commodities, indices and/or derivatives. The investments
by seeking a so-called “absolute” return over a defined can be enhanced by using leverage.
investment horizon, i.e. a performance that is not strongly
In this category, there are sub-strategies:
correlated to the financial markets and that hedges against
■ Macro/Discretionary: unlike the systematic approach,
the main risks associated with traditional asset classes
(in particular market and interest rate risks). the discretionary approach is based on the investment
decisions taken by the manager, reflecting their beliefs
about certain markets and/or sectors.
1.1 The main families of alternative strategies
■ CTA (Commodity Trading Advisors)/Systematic trading:
There are a number of alternative strategies that can be
systematic managers invest in the future and forward
grouped into four main categories presented below.
markets in many underlying assets (equities, interest rates,
currencies, etc.). Investment decisions are taken using
DIRECTIONAL STRATEGIES
quantitative models developed by the fund’s management
These strategies use long and/
team.
or short positions, based on the
managers’ predictions for the
various global markets (equities, Long/short strategies
bonds, currencies, commodities and These strategies combine long positions on undervalued
their derivatives). stocks and short positions on overvalued stocks. They give
managers considerable flexibility, allowing them to adjust
net exposure to the market depending on how optimistic
they are about the future. The manager usually specialises
Global macro Event-driven by sector, by region or by market capitalisation. The use of
leverage is common and allows managers to strengthen
their positions.
The sub-strategies include:
Multi-strategy ■ Sector long/short: the manager has expertise in a particular
Long/short industry (e.g. financial, technology, etc.).
■ Geographical long/short: the manager specialises in a
Arbitrage particular geographical area, thus benefiting from in-depth
knowledge of local markets and their characteristics,
particularly in regulatory terms.
■ Short sellers: these funds only use short positions.
They look for securities they consider to be overvalued
NEUTRAL STRATEGIES
and which they anticipate will drop in price. Their main
These strategies attempt to routinely
selection criterion is the deteriorating fundamentals of the
profit from the discrepancies and
changes in asset valuations on
issuer.
different markets.
As such, relative value strategies Event-driven strategies
are carried out regardless of market Event-driven strategies make the most of the specific events
trends. that occur in the lives of businesses: restructuring, mergers/
acquisitions, spin-offs, etc. These strategies are typically
less affected by market trends.
In this category, there are the following sub-strategies:
■ Activists: these managers buy a share of the floating capital
of a company and become involved in the governance
and strategy of the firm by imposing their vision and
experience. In so doing, they hope that the value of the
firm will increase.

34
■ Distressed securities: a “distressed” manager invests in These four families of strategies can be implemented
securities, mainly bonds or bank loans, which are highly regardless of the type of vehicle (see section 1.2 below).
undervalued due to bankruptcies or during bailouts. This
strategy is most prevalent in the United States, where the 1.2 Categories of alternative strategy vehicle
legislation is favourable.
The international universe of funds using alternative
■ Merger arbitrage: this strategy aims to take advantage strategies is vast. It includes many types of vehicle with a
of differences in valuation caused by an ongoing takeover wide variety of risk, liquidity and expected return profiles.
bid or merger. To do this, the manager usually takes a However, it is possible to group these structures together
long position on the target and a short position on the into the four major categories listed below.
purchaser, either before the transaction is announced or
after the announcement. Newcits
These funds implement alternative investment strategies
Relative value strategies in accordance with the traditional European regulatory
Relative value managers use market imperfections to framework for investment funds known as UCITS. This fund
generate performance. They try to identify price or classification, regulated by a more restrictive framework,
performance differentials that are not justified by the offers greater protection in several areas, particularly in
economic situation of an issuer or market in order to take terms of rules regarding diversification, leverage, valuation
advantage of such discrepancies. and managing counterparty and liquidity risks. These funds
The sub-strategies in this category include: are almost automatically granted a European passport.
■ Fixed income arbitrage: these funds take advantage of price These features, as well as improved transparency and
discrepancies in the bond markets. The use of derivatives reporting, have led to rapid growth in the volume of assets
is an integral part of this strategy and often makes it a held by this kind of fund. However, these funds remain
little more complex to analyse risk and measure leverage. complex in some cases, because of their alternative
■ Equity market neutral: market neutral managers seek to management strategies.
minimise market risk by balancing long and short positions On the other hand, usually because of the need for a high
in common sectors to maintain near zero net exposure to level of liquidity, some sub-strategies (activist, distressed)
the market. of certain strategy families (event driven, relative value)
■ Convertible arbitrage: the fund makes a trade-off between cannot be transferred to UCITS-compliant funds.
a convertible bond, with a generally long position, and
the corresponding share, with a generally short position.
Depending on their expectations, managers may hedge or
maintain certain risks (equity, interest rate, volatility and
credit) related to their position.

35
 Managed accounts Single hedge funds
For over 20 years now, investors have been able to subscribe The management policies of single hedge funds are varied
through managed accounts. These accounts (often sub- and are sometimes based on an active search for returns,
funds of a SICAV or a comparable structure) are held by meaning that risks can be high. However, this universe has
specialised platforms. A hedge fund manager is appointed become highly institutionalised and, due to the significant
to implement their usual management strategy, with volumes subscribed by institutional investors, a search for
predefined constraints and risk limitations: liquidity, market more reasonable and consistent returns has become very
risk, diversification, management of counterparty risk, common.
valuation, asset segregation, etc.
At the end of March 2013, 68% of hedge fund management
The assets remain under the control of the managed account companies had more than USD 5 billion of assets and 90%
platform (full transparency), which is also free to determine had more than USD 1 billion. As for the funds themselves,
the counterparties with which the manager will work. 80% had over USD 1 billion of assets and 90% had at least
Operational risk is almost completely transferred from the USD 500 million.
manager to the managed account platform.
In general, multiple-strategy single hedge funds are less
The universe of managed accounts is very large. Prior to risky than their single-strategy counterparts.
any subscription, investors must therefore carefully read
The acquisition of this type of product should be subject to
the documentation for each managed account and properly
special scrutiny because of its specific characteristics, and
understand how it works.
must involve an appropriate portion of the investor’s wealth
Compared with other alternative investment vehicles, there or correspond to an investor’s particular asset allocation
are additional costs associated with a managed account. needs.

Funds of hedge funds

A fund of funds is comprised of a portfolio of pure hedge funds
(usually around 20) which enables investors to diversify
their risk across multiple strategies and/or managers.
The risks (particularly volatility) of direct investment in a
single hedge fund (see section iv below) can therefore be
greatly reduced since the investment is made through a fund
of hedge funds, allowing for broad diversification in terms of
both strategies (multi-strategy approach) and hedge fund
managers (multi-manager approach).
Their level of risk is generally much lower than that of an
equity fund, for example, and they offer more consistent
profitability that is less dependent on the financial markets.
This hedge fund approach is therefore a good diversification
opportunity for most retail investors. Given how funds of
hedge funds are structured, however, management fees are
higher than for single hedge funds.

36
2 Why invest in a product that uses alternative strategies?
The objective of an alternative management approach is to achieve absolute returns which have low correlation to market indices.
The strategies implemented by the fund to achieve these absolute returns have very different characteristics in terms of
profitability and risk, which potentially make it possible to take advantage of all market phases (bull, bear or flat).
Investing in these funds can help optimise risk-return, offering the prospect of attractive gains for a given level of risk
(volatility). For instance, the Newcits, multi-strategy funds of hedge funds and single hedge fund portfolios/mandates offered
by BNP Paribas seek to preserve capital, break market correlation and achieve limited volatility while providing higher returns
than bonds over a medium-term/long-term investment horizon. The single-strategy funds of hedge funds and the single hedge
fund portfolios/mandates, depending on the approach adopted and/or strategies implemented, offer superior performance
goals with a little more volatility.
The chart below shows the impact of adding funds of hedge funds to a portfolio of stocks and bonds (between January
2000 and March 2013).

Annualised performance
7.0%

Global bond index

6.0%
HFRI composite index

5.0%

Balanced portfolio with HF:

4.0% > 40% equities
> 40% bonds Balanced portfolio without HF:
> 20% hedge funds > 50% equities
> 50% bonds
3.0%

2.0%

1.0%

0.0%
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%
Annualised volatility

■ Reduction in overall portfolio volatility

■ Reduction in maximum decreases
■ Reduced sensitivity to financial markets

Composition of the balanced portfolio without hedge funds:

50% global equity index + 50% global bond index
Composition of the balanced portfolio with hedge funds:
40% global equity index + 40% global bond index + 20% fund of hedge funds index
Global equity index: MSCI World (USD)
Global bond index: JP Morgan Aggr. Bond Index (USD)
Composite hedge fund index: HFRI Funds of Funds Index (USD) Sources: MSCI, JP Morgan Aggr. Bond Index, HFR

37
 3 W
 hat are the main risk components that
should be considered when investing using
3.2 Information risk

alternative strategies?
Vehicles using alternative management strategies have a
variety of constraints in terms of valuation and reporting
depending on the fund’s regulations or mode of operation.
For instance, investors in funds using alternative strategies
3.1 Risk linked to the use of leverage are sometimes provided with very little information. The
occasionally complex strategies of investment funds applying
The level of risk may be increased if the manager uses
an alternative management methodology may seem rather
leverage, i.e. takes positions (by borrowing) which are
opaque to investors. This phenomenon may be exacerbated
greater than the total amount paid in by the investors, with
when the fund is not subject to strict regulations (such as
the aim of securing higher gains than would have been
those which apply to Newcits, for example).
achieved with the nominal capital.
In this case, access to information is limited and possible only
In this case, a small movement in the market can lead to
through direct or indirect contact already established with
significant gains but also to substantial losses. In extreme
the fund and/or management company. That is why strategy
cases, as for any type of investment, a total loss of the
changes, which can lead to a significant increase in risk,
capital invested may occur.
are often misunderstood or completely underestimated by
The use of leverage is strictly regulated in Newcits, and it is investors in an environment with low levels of transparency
contractual and controlled in managed accounts. or reporting. This is not the case for Newcits and managed
accounts, which offer high levels of transparency and, for
Newcits, a statutory obligation to provide regular reports.
The net asset value of a given investment fund is generally
not known (it is usually the value of the previous month
which is known) when the investor decides to purchase or
redeem this type of financial instrument. This is explained
by the fact that notice usually has to be given before any
operation of this kind. As a result, the net asset value can
only be calculated once the purchase or redemption has
taken place.

38
3.3 Market liquidity risk Furthermore, due to the complexity of the underlying
investments made by these funds, it may be necessary
Funds using alternative strategies have very different
to adjust the net asset value after receipt of the audited
degrees of liquidity, which can sometimes be extremely
financial statements. Therefore, some alternative funds
limited.
may retain a portion of the investor’s units or shares if
Overall, for single hedge funds and funds of hedge funds, the the investor decides to redeem 100% of their units/shares,
breakdown of liquidity is as follows: 22% daily, 8% weekly, pending receipt of the audited accounts.
40% monthly, 24% quarterly and 6% less frequently (source:
In most cases, managed accounts offer much more flexible
HFR report of 30 June 2013).
liquidity (monthly, weekly or even daily) and at short notice.
These investments may sometimes be subject to minimum
As for Newcits, they offer high levels of liquidity: in most
holding periods known as lock-ups or to penalties if the
cases daily (83% of the market at the end of September 2012)
investor wants to exit the fund before the end of a given
or weekly (16% of the market at the end of September 2012).
period (less true for funds of hedge funds). This is explained
In any event, regulation provides that redemption must be
by the sometimes relatively low levels of liquidity for
possible at least twice a month.
investments contained in hedge fund portfolios, which are
designed with the long term in mind.
Moreover, among the techniques used in alternative
investments, some involve financial instruments which
are illiquid or subject to legal restrictions on transfers or
other operations. It is therefore possible that the sale of
an alternative investment is permitted only periodically or
on certain dates, after a notice period of several weeks, for
example, four times a year on specific dates.
For hedge funds, in most cases, redemptions are possible
only monthly, quarterly or annually.

39
 3.4 Risks related to regulatory provisions 3.5 Risk related to management techniques
We can draw a distinction between funds that comply with The funds in which the client has invested may make short
the standards of the European UCITS directives (Newcits) sales of securities (i.e. sell securities that they do not own or,
and those that do not. The UCITS standards have been in most cases, that have been borrowed, in order to seek a
refined over time and are intended to provide a satisfactory return from an overvalued asset that is expected to drop in
level of protection for investors, particularly in terms of the value). This technique is likely to expose the portion of the
management rules applied to the funds and the way they fund’s assets involved in such activities to unlimited risk,
are marketed. because there is no upper limit to the price these securities
can reach. However, losses will be limited to the amount
The UCITS directives establish specific rules on permitted
invested in the fund in question.
investments (prohibition on directly holding short posi-
tions, prohibition on investing directly in commodities),
management techniques, rules for diversification, risk 3.6 Risk related to the depositary function
management, publication of net asset value at a minimum In most cases, Newcits, managed accounts and funds
frequency, minimum segregation of assets and functions. of hedge funds have net asset values established by an
Despite the constraints imposed by the UCITS directives, independent external auditor. This is also the case for single
related in particular to fund management, the volume of hedge funds.
assets managed through Newcits has increased in recent However, some funds do not have their NAV validated by
years. auditors (except when calculated at year-end). In these
Non-UCITS funds may be subject to minimal regulations and cases, to value the funds, the bank primarily uses non-
relatively flexible oversight, and may therefore offer varying validated financial information provided by administrative
levels of protection to investors. staff and/or market-makers. When the financial information
used by the funds to determine their own NAV proves to be
Problems or delays may occur in the execution of orders for incomplete or incorrect, or when the NAV does not reflect the
unit subscriptions or redemptions for certain single hedge value of the investments made by the funds, the valuation of
funds, for which the bank cannot be held liable in any way. these assets becomes inaccurate.
There is not always a guarantee that investor rights are
enforceable. A certain number, if not most, funds charge performance
fees.
Investors attracted to alternative investments must be aware
of these risks. Before making any investment, investors 3.7 Complexity or model risk
should carefully consider the investment products, their
solidity, the asset management rigour and the quality of the Newcits and managed accounts are subject to strict
risk-monitoring system. constraints on custodians, which ensure a satisfactory level
of security.
However, for the hedge funds universe, a new European
directive (Alternative Investment Fund Managers Directive, For some hedge funds, the depositary function is performed
or AIFMD) came into force in July 2013 in all countries of by a broker instead of a bank. These brokers may not
the European Union, with the aim of establishing enhanced have the same credit rating as a bank. In addition, unlike
common requirements for accreditation, transparency, risk depositary banks which operate in a regulated environment,
control and monitoring of asset managers based in the EU these brokers assume only the task of keeping custody of
and those established in other countries but wishing to the assets but none of the regulatory monitoring obligations.
manage or sell UCIs within the EU. This will have the effect
of further increasing investor protection and of limiting
access to experienced, if not professional, clients.

40
4 W
 hat types of investor should invest in
funds using alternative strategies?

4.1 Those
 with some knowledge of the investment
techniques and their underlying risks
In general, and depending on the type of fund or strategy,
this investment is for clients with good or very good financial
knowledge. The hugely diverse world of funds (from Newcits
and single hedge funds to managed accounts and funds of
hedge funds) includes funds whose approaches or strategies
are accessible to investors with good financial knowledge,
while other funds/strategies require expert financial knowledge.
In particular, before entering into a fund using alternative
strategies, investors should consider in detail the specific
risks associated with the investment. They must also ensure
that they are legally entitled to purchase the product
(depending on local regulations) and that it is not restricted
to a certain category of investors (e.g. professionals).

4.2 Those
 seeking genuine diversification for their asset
holdings
Moreover, as with any asset class, investment funds using
alternative strategies must be used in a way that reflects
the investor profile (risk appetite, technical knowledge and
investment horizon in particular).
To this end, BNP Paribas has a wide range of specialised
products and partners.
Thanks to the selections it makes, BNP Paribas provides
funds which meet strict criteria in terms of transparency,
the use of leverage, and the use of independent directors,
reputable audit firms, professional depositaries, etc.
Before investing in a fund, the investor should find out
whether or not performance fees will be applied. A certain
number, if not most, funds charge performance fees. This is
a variable fee, often charged annually, which is paid to the
management company if, and only if, performance reaches a
level defined in advance in the rules and regulations of the
fund (or a trigger threshold). This fee is charged in addition
to the annual management fees.

Taxation
It is important that you seek independent advice about the
taxation applicable to vehicles using alternative strategies.

Your advisor is available to provide any further information you

may require and will assist you in your choices, according to your
personal needs and investment profile, before any investment
decisions are made.

41
 INVESTING IN STRUCTURED PRODUCTS
1 What is a structured product? Static financial instruments are derivatives traded on
regulated or over-the-counter markets, the value of which
varies in response to the movements in a financial asset
Structured products are financial products that can meet
called the underlying security.
all investment objectives, including hedging and limited,
moderate or aggressive speculation, and involve all types They can be grouped into three broad families:
of asset, particularly equities, fixed income securities, credit ■ Forward and futures contracts
risk, foreign currencies, commodities and funds. ■ Swaps
■ Options whose prices are determined using mathematical
Their maturity may be from one week to 15 years and is fixed
at inception. algorithms which model the behaviour of the product over
time and according to various market scenarios.
Structured products are financial products which combine
money market or bond investment (basis of the structured Managed financial instruments are based on many different
product) with a static or managed financial instrument. types of model or structure, including constant proportion
portfolio insurance (CPPI), collateralised debt obligations
Financial instruments used as a basis for structured products (CDOs) and the quantitative management methods used by
are issued by financial institutions and can take the form of: certain hedge funds.
negotiable debt securities, e.g. certificates of deposit (CDs)
with a maturity running from one week to two years or Euro
Medium Term Notes (EMTNs); locally approved structured
funds; or special purpose vehicles (SPVs), e.g. specific
warrants or certificates, generally with longer maturities.

42
2 What are the main characteristics of a
structured product?
2.2 Mechanism
Depending on their sophistication, structured products
involve methods of remuneration for the investor which
are determined according to payoff formulae of varying
2.1 Characteristics complexity.
At maturity, a structured product can be thought of as a Depending on which payoff formula is chosen, investing in
cross between: structured products gives investors an opportunity to:
■ A risk/return trade-off ■ Significantly increase returns on risky products; or
■ A strategy on one or more underlyings ■ Ensure repayment of guaranteed capital at maturity while

In a risk/return trade-off, there are three major categories potentially offering a return higher than the deposit over
of structured product going from the most risky investment the investment period.
profile to the most conservative: Furthermore, there are two major categories of payoff
formulae:
■ Products with capital fully guaranteed at maturity:
■ Those which depend on particular events happening during
- With minimum coupon guaranteed at maturity the life of the product.
- With coupon at risk ■ Those linked to participating in the actual performance of
■ Products with capital partially guaranteed at maturity: the underlying.
- With minimum coupon guaranteed at maturity
 or the certificates/EMTN, Athena, cap & floor, credit-linked note
F
- With coupon at risk
and reverse convertible bond product groups, the “Structured
■ Products with capital not guaranteed at maturity: Products” brochure, which is available on request from your
- With coupon guaranteed at maturity advisor, describes the operating and repayment mechanism of
each product based on the three market scenarios: positive,
- With minimum coupon guaranteed at maturity
negative and neutral.
- With coupon at risk

3 Why invest in a structured product?

As concerns strategies on one or more underlyings, there are
four basic strategies:
■ Directional: betting on a rise or fall in the underlying.
■ Opportunistic: betting on upside or downside potential in
underlyings which could happen at any time during the life 3.1 Original investment products
of the product.
■ Stability: betting on the stability of the underlying asset
By combining a forward/future-type investment with one
or more derivative financial investments on different
throughout the life of the product.
■ Volatility: betting on significant fluctuations in the
underlyings, structured products constitute an integrated
investment product offering both an original return (midway
underlying asset during the life of the product.
between that of a bond and a share) and an extremely varied
During their life, structured products are traded on a one (since there can be many different underlying assets
secondary market which generally enables the investor to and payoff formulae).
sell or buy a product at periods defined by the issuer, at
market rates prevailing at the time. 3.2 Customised products
There are many types of structured product offering almost
limitless combinations to best meet the investor’s needs in
terms of underlying securities, amount, maturity, strategy,
risk/return trade-off and payoff profile.
These structured products can be denominated in different
currencies as the investor sees fit.

3.3 Intermediate-risk products

These often offer an opportunity to invest indirectly in
markets that are not easily accessible to the retail investor,
or in volatile markets, without requiring a direct holding
in the corresponding underlyings, and without feeling the
immediate impact of fluctuations by spreading risk.

43
 3.4 Products for diversification 4.3 Capital guarantee risks
These provide overall portfolio diversification in terms of the Products with a full or partial capital guarantee are aimed
investment profile (intermediate risk compared with other at investors who want to limit or eliminate the risk of loss
investment products), the investment horizon (from very of capital while seeking to profit from a strategy on the
short to very long term) and the underlying asset (all asset underlyings that they have chosen.
classes).
However, there is no guarantee of capital until the product

4 W
 hat are the main risk components that
reaches maturity. Should the investor wish (unexpectedly)
to sell out of the structured product before maturity, they

should be considered when investing in a

run the risk of losing their guaranteed capital through exit

structured product?
penalties, adverse market conditions and other factors.
In addition, the capital guarantee may not be honoured if the
issuer or guarantor were to default.
Products with unsecured capital are designed for investors
4.1 Market risks
with a considerable appetite for risk.
Like all financial products, structured products can be subject
The investor must be willing to accept losing some or most
to high risk because the underlying securities and their
of their original capital on the redemption date in the event
volatility are constantly fluctuating along with the market.
that the value of the underlying has declined or the issuer
Similarly, the market value of a structured product can
has defaulted.
vary significantly under the influence of other factors such
as changes in interest rates or exchange rates (especially
4.4 Constraints related to valuation
if the product is denominated in a currency other than
the investor’s reference currency) and the time left on the Depending on the specific composition of structured
product until maturity. products (packaging a forward/future-type investment with
one or more derivatives based on various underlyings),
Structured products should be offered to investors who have
valuation of such products may be influenced by a number
the necessary knowledge and experience to allow them to
of parameters. To understand these valuations, the investor
evaluate all the characteristics and risks inherent in each
must understand that an overall valuation is not enough, but
product.
that the various product components and parameters must
be analysed to judge its performance.
4.2 Risk related to the complexity or structure
of the product
4.5 Constraints related to secondary market liquidity
As structured products are based on a number of complex
The liquidity of structured product markets is entirely under
parameters (risk/return trade-off, strategy on the underlying
the control of the issuer who commits as part of normal
asset and, occasionally, a complex payoff formula), the
market operating terms to buy or sell the product from/to the
investor must fully understand the mechanisms of the
investor according to various criteria defined at the outset
structured product offered and the results arising from the
(price, frequency and minimum amount). For example, if
chosen valuation or payoff formula, according to various
they wish to exit before maturity, the investor may be unable
market expectations and the nature of the underlying(s).
to sell part or all of the financial assets or be required to sell
them at a significantly lower price.

 arious performance scenarios are detailed in the key information

V
document pertaining to the structured product, together with an
estimation of the future performance based on past fluctuations in
the value of the investment.

44
4.6 Risk arising from early repayment by the issuer 5.2 Complex products
Some structured products give the issuer the option to Structured products come in an almost unlimited variety of
repay the product early (issuer call). In these circumstances, structure combinations , some of which may be particularly
reinvestment conditions may be unfavourable to the investor. complex. For this reason, they are usually reserved for investors
who know the financial markets and have sufficiently broad
4.7 Issuer risk and stable financial holdings to be responsive and cope with
any losses. It is therefore very important that investors should
To limit this risk, the thing to do when choosing issuers is
properly inform themselves of all product risks, for example
look at their credit rating which, depending on the maturity
by consulting each product’s term sheet.
of the investment, should be equal or very close to that of
the BNP Paribas Group (A+), which often issues structured
5.3 Before investing in a structured product, be sure to:
products itself.
■ Have a securities account with BGL BNP Paribas.
However, the investor assumes the credit risk of the issuer
■ Carefully read the standardised KID that summarises the
and the guarantor, if any, defined in the product’s legal
documentation. The ratings of the issuer and the guarantor key and specific features of each product.
reflect the independent opinion of the rating agencies ■ Have the minimum investment amount confirmed, on both
concerned and should not be considered as a guarantee of the primary and the secondary markets.
credit quality. In the event of default by the issuer or even ■ Obtain information on how the product works and the
its guarantor, the investor may suffer partial or total loss of investment context.
the capital invested.

4.8 Risk linked to the use of leverage

Taxation
Applying leverage to structured products can have a
significant positive or negative effect both on the return and It is important that you seek independent advice about the
on the risk associated with the product by accentuating the taxation applicable to structured products.
movement of their underlyings. As such, leverage makes
it possible to make significant gains on a given initial
investment, equal to the premium paid.

Risk connected with the management model

For managed products, this risk is connected with the
appropriateness of the model implemented over the
prospective management period.

5 W
 hat types of investor should invest in
structured products?
In general, structured products are most often intended for
experienced investors.

5.1 Products subject to various regulations

Structured products may be marketed:
■ Either within the regulatory framework of a public offering
(APE), as established, approved and signed by the local
regulator, thus providing adequate security to investors.
■ Or through private investments outside the scope of a
public offering and which therefore provide a lower level
of protection for investors.
Moreover, structured products are subject to specific tax
and/or legal regulations that differ according to the country
or region in which they are sold. Under these conditions,
purchase or subscription of these products can be offered
only to investors who meet local regulatory constraints.

45
 INVESTING IN PRIVATE EQUITY
1 W
 hat is private equity and what are its main
characteristics?
Growth capital
Investment intended to finance the growth of a company
that is already established in its market anyyd is generating
profit. Growth capital finances increases in production and/
Private equity entails investing mainly in unlisted companies or marketing capacities and/or product development and/
at various stages of maturity in order to assist them in their or working capital requirements. The capital investment is
development and then selling them a few years later with most often carried out as a minority shareholder.
the goal of generating significant capital gains.
In this document, the term “private equity” refers to various Buyout capital/LBO (1)
components such as venture capital, growth capital, buyout An LBO fund typically aims to acquire a significant or majority
capital/leveraged buyouts (LBOs1) and turnaround capital. stake in an unlisted company generally involving the
These investments can be made using funds, funds of funds creation of a new governance structure and a new strategic
or secondary investments. plan. Typically, these funds invest in mature businesses with
established growth plans, with the intention of financing
expansion or consolidation, sales growth, reorganisation or
1.1 Principal investment strategies
the disposal of less strategic assets. For example, funding a
company’s growth through a policy of multiple acquisitions
Venture capital
is often referred to as a “buy and build” strategy.
Venture capital means investing in start-up companies
specialising in high-growth areas and/or developing
innovative products. This type of investment has a particular
emphasis on entrepreneurial undertakings as well as
start-ups and less mature companies.

Financing of the research and/

SEED STAGE or development stage of an initial
concept before a business has
reached the start-up phase.

Financing product development and

bringing the product to market.
START-UP STAGE Companies may be in the process of
being set up or right at the start of
trading but they have generally not
yet generated any profit.

Financing a company whose sales

are growing strongly and starting
LATE STAGE
to generate profit, but whose cash
flows are not sufficient to self-
finance.

(1)
Refer to the insert on the next page: “Summary of the LBO technique”.

46
 SUMMARY OF THE LBO TECHNIQUE
A leveraged buyout provides finance for the acquisition of a company based on a contribution from a private
equity fund taking an equity stake through a holding company, with the balance being financed by bank loans.
This technique can maximise return on investment for shareholders who provided equity by taking advantage of the
leverage achieved through these loans. The debt incurred to finance the acquisition is repaid from dividends received
from the target company. Usually, the managers of the target company invest in it alongside the fund, giving them
a common interest in the success of the operation.

Investors/private
equity funds
Ad hoc investment vehicle Security

Target company
management team

100% Debt

Target company Banks

Renegotiation of
operating finance

The leveraged acquisition technique is based on the premise that the target company can produce sufficient profit
(cash flow) to cover the repayment of the debt. If so, the internal rate of return (IRR) for the transaction can be
very high. However, should the company not produce sufficient cash to repay the debt and the interest on it, the
shareholders’ equity investment may be partially or completely lost.

Turnaround capital
Turnaround capital involves purchasing firms in difficulty, which require an operational and/or financial restructuring.
The objective is to implement a recovery plan.

47
 1.2 Main characteristics of a private equity fund %
100

Structure of a private equity fund 80

Example of the simplified private equity fund structure 60

40

20

0
Fund managers Investors
(20)
EUR 1 million EUR 99 million
(40)
(60)
(80)
1 2 3 4 5 6 7 8 9 10
Amount committed (100) Year
EUR 100 million
Source: EVCA – Why and How to invest in Private Equity

Company A Company B Company C

Etc.
EUR 10 million EUR 8 million EUR 3 million
Example of the typical life cycle of a private equity fund
Source: EVCA – Why and How to invest in Private Equity
At fund close: initial investment
Years 1-5: investment period, capital called up as required
Legal and tax aspects
Years 3-10: capital is repaid as and when companies are
The existence of multiple legal jurisdictions makes it
sold off
difficult to create a common framework for funds suitable
for investors from different legal and tax environments. It is >T
 he repayment period ends after 5 to 7 years
often necessary to create two or more vehicles, with different >P
 rofits are generated from years 5 to 10
legal structures and domiciles, to allow investors from
different countries to co-invest in a shared asset portfolio.
Definitions
From a tax perspective, the structures of these funds are
Minimum commitment:
generally based on the transparency principle. In other
Often between EUR 5 million and EUR 10 million in the case
words, investors are treated as investing directly in the
of a direct subscription to the fund (it is possible to lower
portfolios of underlying assets.
the minimum commitment by setting up feeder funds which
The funds may have different structures, such as limited themselves invest in the master fund).
partnerships in the UK or the United States, FIS (specialised
Managers’ commitment to the fund:
investment funds) in Luxembourg and FCPR (venture capital
The fund’s managers and/or directors tend to invest their
funds) in France.
own capital alongside the investors (usually between 0.5%
These structures provide their investors with a regulatory and 1% of the total fund).
framework that varies according to their country of
Duration of the investment vehicle (limited partnership,
registration. Within the EU, private equity funds do not
FCPR, etc.):
benefit from the framework established by the standards of
The usual duration for a private equity fund investment is
the UCITS directives, which do not recognise private equity
around 10 years, with possible extensions. Throughout this
assets as being UCITS-eligible.
period, the investment is generally not liquid. However,
However, a new European directive (Alternative Investment distributions may be carried out during the life of the fund
Fund Managers Directive, or AIFMD) applicable to all non- whenever one of the companies in the portfolio is sold off.
UCITS funds, including private equity funds, came into force
in July 2013 in all countries of the European Union, with
the aim of establishing enhanced common requirements
for accreditation, transparency, risk control, reporting and
monitoring of asset managers based in the EU and those
established in other countries but wishing to manage or
sell alternative funds within the EU. This will result in the
strengthening of investor protection.

48
Investment period:
The investment period is the investment phase of the fund.
It starts at the end of the subscription period when the fund
first invests in a target, and usually lasts an average of four
to six years.
Management fees:
The management fees charged by the fund traditionally
include annual management fees (between 1.5% and 2.5% of
the total commitments of the fund).
Performance-based fees:
These represent the share of total profits allocated to fund
managers (usually 20%). These fees are commonly referred
to as “carried interest” and are subject to a minimum
preferred return for investors.
Preferred return:
Payment to the management team of their share of the fund’s
profits is normally subject to an annual preferred return on
all the amounts invested (typically around 8% per year).
Early exit:
The investment term of the fund is contractually binding
with no possibility of an early exit from the fund.

49
 2 Why invest in private equity?

2.1 Portfolio diversification and an attractive risk/return ratio

Private equity generally has a low correlation to other asset classes. If a certain amount of their total asset portfolio is
allocated to private equity, the investor reduces the portfolio’s correlation to equity market volatility. Moreover, private equity
has a more attractive risk/return profile (see the chart below):

PORTFOLIOS WITH AND WITHOUT PRIVATE EQUITY

Expected return (%)

12

100% Private Equity US

8
European Equities

10% Cash
4 10% Cash
40% EU Bonds
45% EU Bonds
40% EU Equities
45% EU Equities
10% PE
European Bonds

0
0 2 4 6 8 10 12 14 16 18 20
Volatility/Risk (%)

BENCHMARK INDICES
Bonds: 10-Year Treasury Bonds (January 1971 – December 2017).
Equities: DJ EuroStoxx 600 (December 1987 – December 2017).
Private Equity: EVCA (December 1987 – December 2017). Sources: Strategic-A/Encorr

2.2 Seeking absolute returns 2.3 Privileged

 access to unlisted companies and creation
of long-term value
Historically, the private equity sector has outperformed
other traditional asset classes such as shares and bonds, as Individual investors, generally through feeder vehicles,
a result of a number of factors: can now access private equity funds that were previously
■ An active role in the reorganisation of businesses to reserved for institutional investors.
achieve better performance (breaking up of failing groups The cash flow structure of a private equity fund concentrates
and selling off of non-core businesses). on creating long-term value, thereby generating attractive
■ Ongoing monitoring and advice provided to companies’
absolute returns which can offset limited liquidity.
management teams (regular reporting by companies to
the shareholder funds and involvement of the private
equity fund in strategic decisions).
■ More effective corporate governance required by private
equity funds.
■ A cash flow optimisation culture, due to the need to repay
the acquisition debt, and greater performance from the
management team.

50
3 W
 hat are the main risk components that
should be considered when investing in
3.5 Illiquidity and investment over the long term

private equity?
Private equity is a long-term investment. Investors may
not sell, transfer or freely exchange their stake in a fund
and may not be able to withdraw from the fund before
maturity. There is no public market which sells interests in
private equity funds, and no organised secondary market is
3.1 Success of the fund and investment performance
likely to develop in the future. It may therefore be difficult
The success of an investment in a private equity fund for the investor to sell their interest, or to obtain reliable
depends on the ability of the investment team to identify information as to the value of their investments and the
and execute appropriate investments in the underlying extent of the risk to which they are exposed. As a result,
companies or funds. The gains or losses realised depend investors in private equity must be prepared to accept the
on the quality of the decisions taken by the manager of the risks inherent in holding an interest in a private equity fund
private equity fund and whether or not their management over an extended period of time.
decisions are put into practice over time. Consequently,
the quality, expertise and continuity of the teams in charge 3.6 Valuation difficulties
(departure of any key personnel) are important risk factors.
There is no guarantee that the investments will or can be The valuation of an investment by any private equity fund
made, or that the investments will prove profitable. aims to give a true and transparent reflection of the intrinsic
value of that investment. Nevertheless, the real market
value of an unquoted investment cannot be determined until
3.2 Investment in an unlisted company
that investment is sold.
Investing, even indirectly, in an unlisted company involves

4 What types of investor should invest in

a high degree of risk, as such companies may be small,

private equity?
vulnerable to changes in the markets and dependent on
the skills and commitment of a management team that
may only comprise a few people. These factors increase the
likelihood that such companies may encounter difficulties
likely to cause a significant loss of value. Private equity funds are aimed at investors who are:
■ Experienced and familiar with the business world.
3.3 Unsecured investment capital ■ Legally entitled to invest in a private equity fund (according

A private equity investment may involve a risk of capital to local regulations).

losses. As such, the investor can have no guarantee as to ■ Aware of the illiquid nature of investments in unquoted

the capital invested and must therefore allocate a limited companies (no secondary market).
proportion of their assets to private equity. ■ Able to hold the investment in the medium or long term.
■ Seeking high rates of return and relative outperformance
3.4 Leveraged transactions compared with traditional asset classes.
■ Keen to genuinely diversify their holdings by means of
The manager of a private equity fund can use leveraged
exposure to private equity, which has historically shown
transactions, which by their very nature involve a high degree
low correlation to the equity markets.
of financial risk and thus increase the exposure of companies

Taxation
to adverse economic factors such as the deterioration of
credit conditions and sources, increases in interest rates,
economic recession or deteriorating market conditions in the
sectors where these companies operate.
It is important that you seek independent advice about the
taxation applicable to private equity.

Your advisor is available to provide any further information you

may require and will assist you in your choices, according to your
personal needs and investment profile, before any investment
decisions are made.

51
 INVESTING IN DERIVATIVES
1 What is a derivative and what are its main
characteristics?
Classification of derivatives
There are two main types of derivative:
■ Unconditional contracts which are firm commitments,
such as futures, forwards and swaps.
A derivative is a financial instrument whose value depends on ■ Conditional contracts (vanilla and exotic options) in which
one or more underlying assets traded on markets (equities, the buyer of the option can choose whether to adhere to
interest rates, exchange rates, commodities, etc.) as well as the terms of the contract, whereas the seller is obliged to.
factors such as climatic conditions, etc.
Derivatives can be traded on two types of market: organised 1.1 Unconditional contracts
(or listed) and over the counter (OTC).
Futures
Listed contracts are standardised. They are processed and
A futures contract is a firm commitment to buy or sell a
administered through a clearing house.
quantity of an asset at an agreed price on a future date.
Over-the-counter contracts are confidential, non- It requires the buyer to buy and the seller to sell the
standardised and traded between two parties. The main underlying product at maturity. Futures contracts are
advantage of the OTC market is the ability to handle products traded on organised markets and their characteristics are
on a case-by-case basis; the major risk is that one party may standardised.
default.
When a futures contract is signed, the contract amount is
The potential gains and losses from derivatives can be not paid (or received) in full. An initial payment is deposited
considerable (even unlimited in extreme cases). These gains with a clearing house. During the life of the contract, the
and losses are realised at the maturity of the derivative for investor’s account is adjusted to reflect the gains or losses
products traded on the OTC market. In the case of products (margin calls).
traded on organised markets, the investor must be able,
every evening, to handle any potential losses estimated by
the clearing house.
It is also necessary to sign contractual and specific
documentation with BGL BNP Paribas, with whom the
derivative is concluded, setting out all the features of the
product.

52
A futures contract has the following features: The price of an option is called the premium.
■ Underlying asset (bought and sold): currencies, commo- ■ The option buyer pays the premium for the right to exercise
dities, shares, indices, etc. their option. Any potential loss is limited to the premium
■ Contract size (quantity of underlying assets exchanged at paid when setting up the operation.
maturity). ■ The option seller receives the premium in exchange for
■ Contract maturity: delivery frequencies vary from contract the obligation to buy or sell the asset. Any potential loss
to contract. is unlimited. The option seller is asked to establish a line
■ Delivery method: in some cases, the place of delivery. of credit.
■ Amounted initially deposited and the margin calls.
Exotic options
When the operation is set up, there is no exchange of cash Exotic options are options whose repayment profiles depend
flows. The underlying asset is exchanged at the maturity of on a number of criteria:
the contract.
■ Binary option

Forwards This is an option with an “all or nothing” payoff, which

A forward contract is a firm commitment to buy or sell a pays a predetermined amount when exercised. This type
quantity of an asset at an agreed price on a future date. of option is frequently used when setting up structured
Unlike a futures contract, a forward is traded on an OTC products involving different asset classes.
market. ■ Asian option

A forward contract has the following features: This is an option with a payoff that depends on the average
■ Underlying levels of the underlying observed over a given maturity
asset (bought and sold): currencies,
and frequency.
commodities, shares, indices, etc.
■ Contract size (quantity of underlying assets exchanged at ■ Barrier option
maturity) This is an option whose very existence is conditional upon
■ Contract maturity: delivery date either its activation (knock-in) or deactivation (knock-out);
■ Delivery method: the standard is delivery in cash this kind of option is used in structured products called
■ A single flow at the end of the contract barrier products.
■ Worst-of/Best-of option
Swaps This is an option whose payoff depends on the performance
A swap is an exchange of cash flows between two parties, at of the underlying with the lowest or best performance
an agreed frequency and over a given period, concerning a from a basket of securities.
predetermined notional amount (no exchange of the nominal ■ Callable/Autocallable
amount at inception). This is an option that features early redemption at the
Swaps are OTC instruments (not administered via a clearing issuer’s discretion or subject to changes in the underlying.
house) which are made to measure and which involve a Whether vanilla or exotic, all options feature the following:
counterparty risk on the flows. They may focus on different ■ Underlying asset (bought and sold): currencies, commo-
asset classes (interest rates, credit, foreign exchange,
dities, shares, indices, etc.
equities, etc.).
■ Nominal (amount of underlying assets exchanged at
maturity)
1.2 Conditional contracts
■ Maturity: the date on which the option expires
■ Strike price of the option
Vanilla options
■ Price of the underlying asset
There are two categories of vanilla option: calls and puts.
■ Option premium
■ Call option: gives the buyer the opportunity to buy and
■ Payoff formula or result at maturity
the seller the obligation to sell the underlying asset at a
■ Plus some unique characteristics specific to exotic options
specified price (called the strike price).
■ Put option: gives the buyer the opportunity to sell and It should be noted that the volatility which helps determine
the seller the obligation to buy the underlying asset at a the price of the option serves as a parameter for quantifying
specified price (called the strike price). the risk taken on the underlying asset, since it measures the
magnitude of changes in the underlying asset price.
There are two types of strike:
■ American option: this can be exercised at any time until
maturity.
■ European option: this can be exercised only at maturity.

53
 2 Why invest in derivatives? it at a significantly lower price. Finally, some derivatives
may become relatively illiquid or encounter high levels of
volatility or a decrease (or increase) in value, reducing the
The main advantages of investing in derivatives are:
relevance of their value in the portfolios or even making
■ The potential for significant financial gains from a small
such valuation impossible.
initial investment (leverage).
■ The use of suitable hedges.
3.4 Counterparty risk
For experienced investors, derivatives make it possible to use With derivatives, each investor bears the credit risk of
more complex and/or more targeted speculative strategies the counterparty to the transaction. The ratings of the
than direct intervention on the market for the underlying counterparty reflect the independent opinion of the rating
asset. agencies concerned and should not be considered as a

3 What are the main risk components that

guarantee of credit quality. In the event of default by the
counterparty, the investor may suffer partial or total loss of

should be considered when investing in

the nominal amount.

derivatives?
3.5 Credit risk
For the seller of a derivative (e.g. an option), credit risk
also needs to be taken into account. This risk is related to
3.1 Market risk the possibility of an unfavourable trend in the underlying
asset, which may cause irregularities that then have to be
The market value of a derivative can vary significantly under
corrected by reducing exposure or strengthening collateral.
the influence of various factors, such as the performance and
The level of collateral required from the investor and the
volatility of the underlying assets, changes in interest rates
method used to value it depend entirely on the Bank.
or exchange rates (especially if the product is denominated
in a currency other than the investor’s reference currency),
the economic and financial environment in the country/ 3.6 Risk of unlimited loss when selling an option
countries concerned, and the time left on the product until When selling an option, it is important to understand that
maturity. the risk of loss can be unlimited if the price of the underlying
asset moves unfavourably.
For derivatives related to credit markets, the default risk
of the various issuers of the underlying bonds depends on
their quality (reflected by their ratings, where available) and 3.7 Conflicts of interest
the macroeconomic environment. The investor should know A number of conflicts of interest (actual or potential)
the quality of the issuers of the bonds associated with the may arise from the general investment activities of the
options in question. On the other hand, bond prices can vary parties involved in the transaction, of their investment
greatly between the issue date and the maturity date. This professionals or their affiliates. Specifically, the counterparty
price variation is partly related to the interest rate on the or its affiliates may recommend/manage other investment
market. vehicles whose interests may differ from those of the holders
of the derivatives in question.
3.2 Option pricing risk
Since options are created using complex parameters, the 3.8 Risk linked to hybrid products and exotic options
investor must fully understand the mechanisms of the The risks associated with hybrid products and exotic options
derivative offered and the results arising from the valuation are the same as those associated with OTC options, but there
or the payoff formula chosen, according to various market are other factors that must be taken into account (possible
expectations and the nature of the underlying asset(s). correlations, specific features of exotic options, etc.).

3.3 Liquidity risk

The liquidity of derivatives is entirely under the control of
the counterparty, who chooses whether to commit as part of
normal market operating terms to buy or sell the derivative
from/to the investor according to various criteria defined at
the outset (price, frequency and minimum amount). If they
wish to exit before maturity, the investor may be unable to
unwind part or all of their derivative or be required to unwind

54
4 What types of investor should invest in
derivatives?
Derivative products are generally suitable for experienced
investors who can understand the often complex trajectories
of these products. We recommend that you perform market
simulations on derivative product positions in order to gauge
their possible development and thus make fully informed
decisions. Furthermore, derivative product positions should
be monitored frequently (ideally, daily) as they change very
quickly in accordance with their underlying asset, volatility
(leverage effect) and the time remaining to maturity (time
value decay).

 rior to investing in a derivative, investors should carefully read

P
the standardised key information document (KID) that summarises
the key and specific features of each product.

Taxation
It is important that you seek independent advice about the
taxation applicable to derivatives.

Your advisor is available to provide any further information you

may require and will assist you in your choices, according to your
personal needs and investment profile, before any investment
decisions are made.

55
 INVESTING IN WARRANTS
1 W
 hat is a warrant and what are its main
characteristics?
■ Put warrant: option to sell the underlying asset at the
strike price.
For European-style warrants, the investor is entitled to
buy or sell the underlying asset at maturity. For US-style
A warrant is a transferable security that works in a similar
warrants, investors are entitled to do so throughout the
way to an option. In exchange for a premium, it gives
lifetime of the product.
investors the right (but not the obligation) to buy or sell:
■ A given quantity of a specific asset known as the underlying. Parity: this is the number of warrants required to exercise
■ At a predetermined price known as the strike price. one’s right with respect to an underlying. Each warrant has
■ At any time within a predetermined time limit or on a its own parity. For instance, a parity of 10 on an equity call
warrant means that you must buy 10 warrants to be able to
predetermined date known as the maturity.
buy a share at the strike price on the maturity date.
The premium is the transaction price of the warrant.
Warrants are financial instruments belonging to the category
These parameters are fixed on the day the transaction is of securities (bonds, shares, etc.). They are not derivatives
concluded. The underlying may be, for example, a share, like options, although they function in a similar way.
an index, a basket of shares, a commodity or a pair of
Unlike options:
currencies.
■ Warrants can be bought, but they can be sold only if
Just like for options, there are two types of warrant: the investor actually owns the warrant as part of their
■ Call warrant: option to buy the underlying asset at the portfolio. Warrants cannot be sold short.
strike price. ■ Warrants tend to be issued by financial institutions which
are authorised to issue securities.

56
The issuer communicates on the market in order to solicit ■ The lifetime of the warrant
investors’ interest, stimulate demand and thus ensure a
When the market expects the underlying to fluctuate
certain level of liquidity.
sharply, its volatility is high and is reflected in the value
Warrants can be listed on a stock market like a share. of the warrant, which is more expensive because there are
more opportunities to make money.
Since listing is optional, a certain number of warrants are
traded over the counter under the terms of a simple contract. Similarly, the longer the warrant’s lifetime, the higher the
probability of significant change in value of the underlying.
Usually, the liquidity of the warrant markets is high enough
A warrant with a long maturity is therefore riskier than
for investors to be able to sell a warrant at any time until
a warrant with a shorter maturity, but it does offer more
a date a few days before the maturity date, defined on each
opportunities to make money.
stock exchange or market.
Finally, the level of the strike price, which is chosen in relation
For most warrants, a cash settlement at maturity is chosen
to the price of the underlying at the time of the warrant
by the issuer. This is always the case for put warrants.
purchase, is paramount because the gain at maturity will
Price factors for a warrant: depend not only on the trend observed over the warrant
As for an option premium, the price of a warrant depends on lifetime, but also on its scale.
several market variables: The opportunities and risks of such a speculative investment
■ The value of the underlying asset (share, index, basket, will depend on the combination of these three main factors.
commodity, etc.). It is therefore essential that the investor fully understands
■ The prospective movements in the price of this underlying the warrant’s sensitivity to changes in these parameters in
compared with the chosen strike price, and the volatility. order to make a profitable purchase.

57
 2W
 hy invest in warrants?
■ The warrant is a speculative financial instrument: it offers
high potential gains as well as a high level of risk. Its
specific feature is that it offers leverage, i.e. it accentuates
upward and downward movements in the price of the
underlying asset in question. As such, leverage makes
it possible to make significant gains on a modest initial
investment, equal to the premium paid.
■ Warrants also allow investors to open a speculative
directional position on a specific underlying asset, without
buying it directly. If investors expect changes in the value of
an underlying asset, but wish to limit their loss in the event
of an unfavourable price movement, purchasing a warrant
with wisely chosen parameters (strike price and maturity)
allows them to bet on the price move while limiting their
losses to the purchase price of the warrant instead of the
price difference which they would have had to bear had
they bought the underlying asset directly. Again, leverage
enables the investor to invest a modest initial amount and
yet back an idea for a much higher nominal amount for
which they may not have the corresponding cash available.
In the specific case of portfolios that are heavily invested in
the underlying, certain warrant strategies (put purchases)
may enable potential losses in the event of a sharp downturn
in the underlying to be hedged or limited.

3W
 hat are the main risk components that
should be considered when investing in
warrants?
Market risk
The main risk with a warrant is that market conditions on
maturity mean that there is no point in buying the underlying
asset at the warrant strike price. For example, if an investor
buys a call warrant on a share at a strike price of 100 but
sees that the share price is 80 when the warrant matures,
there would be no point in the investor exercising their
warrant and it would make more sense to buy the share at
80 directly on the stock market. In such a case, the investor
would lose their initial investment (the premium).

Risk of capital loss

The value of a warrant decreases over time. But this time
decay is not linear: the closer the warrant is to the maturity
date, the faster the time value (and thus the warrant value)
decreases. An approximate estimate is that a warrant loses
about two thirds of its value over one third of its lifetime. It is
therefore sometimes better to sell the warrant early enough
to realise a profit and offset the loss due to time value.

58
Counterparty risk
There is also a counterparty risk in relation to the warrant
issuer: it is important to buy the security from a major
financial institution.

4W
 hat types of investor should invest in
warrants?
Warrants are only suitable for very experienced investors
who are able to understand the often complex trajectories
of such products and their high degree of sensitivity to
movements in their quotation parameters.
The choice of the different warrant parameters is paramount
in achieving significant gains. It should optimise the strike
price and maturity in line with expectations for the market,
while minimising the negative effects associated with the
sharp decline in time value at the end of the warrant’s life.
In order to optimise their choices, investors should have an
excellent knowledge of complex option-type products as
well as a thorough knowledge of the underlying market.
Price movements in purchased warrants should be
monitored to detect any opportunities related to a dynamic
management of these extremely volatile instruments.

Taxation
It is important that you seek independent advice about the
taxation applicable to warrants.

Your advisor is available to provide any further information you

may require and will assist you in your choices, according to your
personal needs and investment profile, before any investment
decisions are made.

59
 INVESTING IN AN UNLISTED REAL ESTATE FUND
1 What is an unlisted real estate fund and what
are its main characteristics?
An indirect investment can be made:
■ Through listed vehicles (real estate investment companies,
exchange traded funds). Their shares are subject to daily
liquidity. Listed real estate is more liquid and diverse than
unlisted real estate. However, it is more sensitive to stock
1.1 Background
market fluctuations.
Traditionally, investing in real estate was synonymous with ■ Through an unlisted private structure managed by a
direct, physical investments. management company. This company is responsible for
Now, however, there are a number of investment vehicles investing in, managing and trading property, depending on
and legal structures available which make it possible to market opportunities. It aims to optimise the profitability
invest in real estate indirectly. Investing in a real estate fund of the fund over an often predetermined period of time.
therefore represents an alternative to direct investment There are numerous legal structures, often specific to each
and the transaction can be entrusted to real estate market country. Securities are traded over the counter.
professionals.
The most frequently used benchmark for measuring
performance is the Investment Property Databank (IPD). It
provides the real estate investment market with information
comparable to that of regulated markets (Europe, United
States, Asia).

60
1.2 What are the main characteristics of an unlisted real estate fund?
There are three main strategy types: core, value added and opportunistic. They offer varying risk/return ratios and levels of
added value, depending on the degree of recourse to financial leverage and active asset management.

Return

High OPPORTUNISTIC

Medium VALUE ADDED

CORE
Low

Low Medium High Risk/Use of leverage

Investing in targeted as- Creating value Increasing the value

sets benefiting from good by improving the rental of new or under-priced
liquidity and offering performance of the assets assets
steady income in the fund
■ Management:
■ Management: ■ Management: dynamic
not very active and dynamic ■ Leverage:
cautious ■ Leverage: high
■ Leverage: moderate/high ■ Horizon:
low ■ Horizon: medium term
■ Horizon: medium term ■ Borrowing of around
long term 75% but up to 100%
■ Performance targets of
more than 20%

The investment zone can be single- or multi-country and 1.3 Investment structure
single- or multi-sector (housing, offices, shops, hotels, etc.),
An investment in an unlisted product may be made via a
thereby enabling varying degrees of diversification.
feeder fund or directly in the master fund.
The expected duration of an unlisted investment fund varies
Depending on the structure in question, a direct investment
from six to ten years, including a property acquisition period
in a master fund is associated with a level of investment
of two to four years.
of more than EUR 1 million, while the average feeder
The return objectives are expressed as a net, pre-tax fund investment ticket is usually around EUR 150,000 to
Internal Rate of Return (IRR). Calculated as a percentage, EUR 250,000.
the IRR measures the profitability of an investment based
Investors are therefore generally advised to invest through
on cash flows. Income can be distributed to investors during
the feeder fund.
the fund’s lifetime or at the time of exit from the investment
(liquidation, cease of trading, flotation). Investments in real estate will be made by the master fund
through an ad hoc legal structure. Each investment in a
property asset may be accompanied by varying degrees of
leverage (debt).
The real estate strategy is implemented at the discretion
of a real estate management company (asset manager) to
which the investor fully delegates the management of the
fund and pays a management fee.

61
 2 Why invest in real estate?
In the last 20 years or so, real estate has established itself
as an asset class in its own right, with the following merits:
■ A sizeable market – real estate investment represents
around 15% of global GDP.
■ It provides a useful means of diversifying portfolios with
real assets, since real estate cycles vary in sensitivity by
geographical location and by the broad range of underlying
assets (residential, offices, shops, etc.).
■ It offers a risk/return ratio somewhere between equities
and bonds.
■ It shows a capacity for resilience because of its low
correlation to traditional financial investments (safe
haven).
■ It helps protect against inflation due to regular, stable
income.

3 What are the main risk components that

should be considered when investing in
unlisted real estate funds?
This type of investment combines the risks associated with
investing in the real estate market and those of investing in
an unlisted fund.

3.1 Market liquidity risk

Unlisted companies’ shares cannot generally be sold freely;
there is no secondary market for these shares and no
expectation that one will develop. It is therefore difficult, if
not impossible, for an investor to sell their shares.

3.2 Interest
 rate risk and the risk associated with
changes in the economy
Interest rate risk and the risk associated with changes in the
economy.
Variations in interest rates and financial market volatility
may also restrict the financing solutions available to
potential real estate buyers or those related to setting up
transactions, and therefore push selling prices for these
assets down, thereby reducing the effective return on the
investment.
An economic slowdown or a significant inflexion in real
estate market cycles may affect the local real estate market.

3.3 Risk related to the each fund’s investment strategy

The choice of a real estate strategy must reflect the investor’s
expectations in terms of performance. The financing risks
(leverage) must be also be included – these increase in
proportion to the returns – as well as those linked to the
maturity of the real estate markets and of the construction
sector, as well as the management team’s ability to
implement the desired strategy.

62
 4 What types of investor should invest in
unlisted real estate funds?
3.4 R
 isk connected with the quality of product
management
Making a success of an unlisted company requires a very
specific type of expertise and depends above all on the skill Investing in an unlisted real estate fund provides access to
and commitment of the asset management company. Of investments managed by real estate professionals, which
particular importance is the ability to identify, choose and can respond to the investor’s specific requirements through
acquire appropriate real estate assets and implement the a combination of the following factors:
investment strategy. It is essential to choose a first-class
■ Risk/return profile (core to opportunistic strategies)
asset manager with an excellent track record over several
years (existing funds or successfully completed real estate ■ Investment horizon (medium/long term)
operations).
■ Diversification in terms of geographical regions/real estate
sectors
3.5 Market and underlying asset risk
However, investing in an unlisted real estate fund involves a
An investment in an unlisted company is riskier than an
significant degree of risk in that it implies a medium-/long-
investment in a listed company, as unlisted companies
term investment horizon and carries no guarantee that the
are often smaller and more vulnerable to changes in the
investment will achieve its performance objectives, nor that
markets. Past performance of similar investments cannot
the investor’s capital will be recovered.
serve as a reference or a guide to the returns likely to be
produced by another real estate investment fund. Since This type of investment is suitable for investors who have the
investments are pooled by a single asset manager – an expert ability, the means and the financial circumstances required
in the field – the latter has access to a range of human and to evaluate and accept the risks involved in investing in an
technical resources (research teams, computer simulations, unlisted company (in particular, the lack of liquidity inherent
sophisticated analysis, etc.) which help it improve the quality in this type of investment and the risks associated with
of its decision-making and thus allow all the unit bearers or investing in the real estate market).
shareholders to benefit from improved performance. Given the risks inherent in both unlisted investments and
the real estate market, investors should make sure they
3.6 Regulatory risk have access to transparent information. It is particularly
The regulations and taxation applicable to property important that they receive regular, detailed reports,
investments may be subject to modification, with possible validated by an independent expert, so they can fully assess
consequences for the operational management of the assets. the quality of the assets acquired and verify that the fund
strategy has been properly implemented, and therefore
3.7 Additional risks on emerging markets ensure the smooth running of their investment for its entire
duration.
Investing in a fund which invests significantly in an “emerging”

Taxation
property market must be approached carefully. The asset
manager must carefully analyse the characteristics of each
local market (transparency, property and leasing rights, etc.)
and pay particular attention to the quality and reputation of
the local partners selected. It is important that you seek independent advice about the
taxation applicable to unlisted real estate products.
3.8 Counterparty risk
Your advisor is available to provide any further information you
The counterparty with whom a contract is concluded may
may require and will assist you in your choices, according to your
fail to meet its commitments (delivery of goods, payment of
personal needs and investment profile, before any investment
rent, etc.). The level of risk involved depends on the choice of
decisions are made.
counterparty (property developers, tenants, etc.). In the case
of a fund, this choice is the responsibility of the management
company.

63
 INVESTING IN COMMODITIES
1 What is the commodities market and what
are its main characteristics?
1.1 Market participants
These markets, which are generally still very much the
preserve of professionals, essentially developed in the form
The term “commodities” covers a vast scope, including of organised markets, with a clearing house, futures1) and
markets in raw materials, agricultural and farming products, options. These contracts allow one group of participants
oil and energy sources, precious/rare/industrial metals, (mainly producers) to hedge against unfavourable changes
minerals, etc. in prices, and another group (speculators) to profit
from volatility and fluctuations in the underlyings. The
These markets in generic, fungible and standardised involvement of speculators makes it possible to considerably
products bring together various types of actor carrying out increase these markets’ liquidity and volumes.
transactions in which prices are constantly adjusted to
reflect supply and demand. By their very nature, the prices Settlement on maturity can be carried out via physical
of materials traded on these markets have an intrinsic level delivery of the commodities in question; this mainly occurs
of volatility. when participants are professionals. In this case, the date
and place of delivery, and the product’s characteristics, must
Their various characteristics (quality standards, delivery be stipulated. Quality standards make this approach broadly
conditions, etc.) also result in a proliferation in the number complex.
and terms of contracts which can be traded, producing an
extremely sophisticated range of financial instruments. However, most trades by investors are settled prior to
These markets are therefore among the most complex for maturity with a cash payment of the difference between the
an investor. initial purchase/sale price and the final redemption/resale
price of the forwards or futures. The transparency offered by
these markets also means they can be used as a benchmark
for physical transactions on the spot market.
For retail investors, only gold and precious metals can be
physically delivered or recorded in book-entry form with
their bank.

64
1.2 The main underlying products 1.4 Instruments
■ Agriculture: these commodities are often grouped into
three categories: Futures and options contracts
- Grains: corn, soya, wheat, oats, rice, barley, etc. (see section on derivatives)
- Exotics: cocoa, coffee, sugar, rubber, orange juice, etc. Commodities futures and options generally function in
- Fibres: cotton, wool, silk, lumber, etc. the same way as for other markets. The prices of futures
■ Cattle farming: meat, livestock, etc.
represent the prices that market participants are prepared
to pay/receive at a future date for a fixed quantity of a
■ Energy: oil, petroleum products, gas, coal, electricity
commodity. These futures contracts have the advantage of
■ Precious metals: gold, platinum, palladium, silver
being standardised and listed on an organised, transparent
■ Minerals and industrial metals: iron, copper, aluminium,
and liquid market, and they avoid physical delivery of
zinc, lead, nickel, diamonds, etc. commodities.
As part of its commitment to corporate social responsibility The main organised commodities markets are:
(CSR), BNP Paribas has developed a policy to serve as a ■ For all underlyings, the Chicago Mercantile Exchange
framework for its business activities in relation to certain Group (CME Group) and the Intercontinental Exchange
underlying products linked to commodities, and to ensure (ICE), which recently merged with NYSE Liffe.
that the Bank takes particular care with respect to key ■ For agricultural products, the New York Board of Trade
agricultural commodities (those defined as “grains” by the
(NYBOT).
FAO). The group undertakes not to sell derivatives (futures)
■ For industrial metals, the London Metal Exchange (LME).
with exclusively financial objectives. When an investor wants
to invest in this type of underlying product, BNP Paribas Markets specialising in a specific commodity are mainly
checks that it is purely for hedging purposes. reserved for professionals and investors with extensive
experience in relation to the underlying commodity
1.3 Indices concerned, as the wide array of contracts available makes
trading even more complex. For a more general but still
The main composite indices acting as market benchmarks
sector-based approach, futures based on composite indices
include:
are available with contracts requiring cash settlement on
■ Rogers International Commodity Index® (RICI)
maturity.
■ Reuters/Jefferies CRB® Index (RJ/CRB)
■ Dow Jones-UBS Commodity Index (DJ-UBSCI) Finally, assorted baskets have been prepared for institutional
investors on the theme of “global commodities” to be found
■ Standards & Poor’s Goldman Sachs Commodity Index (S&P
in the main indices.
GSCI™)
■ DCI® BNP Paribas Enhanced (DCI®-B)
Long-only funds specialising in commodities
These indices are constructed to encompass baskets of Over the past few years, management companies have
futures on the various underlying markets. developed a specialised range of funds adopting an index-
based approach that is either general or focused on a specific
They have variable characteristics depending on the
theme.
weighting of the various categories of commodities – either
balanced and diversified, or focused on one of them (e.g. Many indices created by large financial institutions are
energy, metals or agriculture) – and depending on their listed on the market. Many of them require very high initial
geographical scope. investments which are not accessible to all retail investors.
Management companies specialising in commodities offer
Some are listed directly on organised markets via futures
an increasingly accessible range of general and diversified
on these indices (GSCI futures are listed on the Chicago
or theme-based index funds (biofuels, non-GMO, etc.), some
Mercantile Exchange, RJ/CRB futures on the New York
of which are aimed at retail investors.
Board of Trade), and there are index-linked funds or
trackers making these composite markets accessible Furthermore, some enhanced indices and index funds exist
to general investors in the commodities asset class. (e.g. DCI® BNP Paribas Enhanced (DCI®-B)). These funds
use complex mathematical models to take advantage of
differences between spot and futures prices.
Some managers have also developed strategies using a
range of instruments (indices, equity-commodities, etc.)
allowing active management in this asset class.

65
 3 What are the main risk components that
should be considered when investing in
Structured products based on commodities
It is possible to create structured products based on

commodities?
commodities in the same way as on other underlying assets
such as shares. Most standard structured products can be
adapted to underlying commodities or commodities indices.
These products make it easier for retail investors to access
underlying commodities that are sometimes difficult to 3.1 Market risks
access otherwise.
Commodities – and particularly the most common form of
It is possible to develop a wide range of products (yield, commodities, i.e. derivatives (futures and options traded
performance, etc.), offering total or partial capital protection on organised markets) – are reserved for very experienced
(see section on structured products). investors because of their high level of volatility and the
extremely specialist nature of their underlying assets
Commodities funds using alternative strategies (seasonality, market announcements and anticipation of
(particularly long/short funds) production levels, stocks, geostrategic issues for some
The range of funds using alternative strategies and investing markets such as oil, copper and other raw materials, climatic
in commodities is vast and varied. It contains a very wide variations for agricultural products, etc.).
choice of risk/return profiles. These funds offer varying
exposure to commodities, which will be managed actively 3.2 Risk associated with leverage
to capture short-term returns and long-term structural bull
It is possible to obtain leverage on organised markets (initial
trends.
margin allowing investment in a nominal that is multiple of
This type of fund, like all products with underlying the initial capital), amplifying the risk of capital loss.
commodities, is reserved for experienced investors.
3.3 Counterparty and delivery risks

2 Why invest in commodities?

For materials subject to physical delivery, such as gold,
the nature of the transaction (physical or via book entry)
determines the nature of the counterparty risk taken by the
In recent years, commodities have offered a very important investor. A book entry to some extent reflects the investor’s
means of diversification owing to their low correlation to confidence in the financial future of their bank. Physical
traditional asset classes (shares and bonds). Their significant ownership, in a safe for example, does not incur the bank’s
volatility gives these products a speculative appeal. liability in the same way. It is therefore necessary to ask
Investment funds and institutional investors have therefore about the type of contract before carrying out transactions,
gradually added commodities to the range of instruments as well as issues of storage and insurance for the assets in
they use to diversify financial investments. the event of physical delivery.

They have also become accessible to retail investors via 3.4 Country risk and transfer risk
funds and index products mirroring the behaviour of these
markets to varying degrees depending on the number of The political and economic climate in certain countries
underlying products (funds or tracker funds based on these that produce commodities may become unstable, causing
indices or futures based on composite indexes). significant and rapid fluctuation in prices. Country ratings
published in the financial press may be of use to investors
Investors still need to be very experienced, since trading in this respect.
derivatives on an organised market can generate significant
gains from a modest initial investment but also has a high
3.5 Economic climate risk
risk of loss if the market turns. A few precious materials
such as gold and silver are easier to trade. The relative Changes in the activity of a company or market economy
transparency of the market makes them a good portfolio always have repercussions on movements in prices of
diversification asset. financial instruments and exchange rates. Since commodities
are closely linked to the economic climate as physical or
Provided that you fully understand the rules, investing in
consumable assets, they fluctuate based on economic peaks
commodities has three major advantages:
and troughs.
■ Portfolio diversification
■ Performances with a low correlation to shares and bonds
■ Protection against inflation

66
4 What you need to know before investing in Taxation
commodities
It is important that you seek independent advice about the
taxation applicable to commodities.
These markets are generally suitable for very experienced
investors who can understand the often complex changes
in the macroeconomic, political and strategic elements that Your advisor is available to provide any further information you
affect these products. may require and will assist you in your choices, according to your
personal needs and investment profile, before any investment
Like any derivatives, futures and options contracts must
decisions are made.
be approached with caution, particularly in light of the
amplification of gains and losses made possible by leverage.
For investments in funds, index-linked and structured
products providing a higher level of portfolio diversification
than more traditional markets, special attention must be
paid to the product documentation and the composition of
underlying indices. It is important for investors to understand
and accept the implicit management strategies, as well as
the intrinsic characteristics of the structured product (capital
guarantee or highly speculative product, etc.).
Finally, although the volatility of each commodity is fairly
high, combining several in one basket allows greater control
over this volatility to some extent, since commodities in
different categories have a low correlation to each other. For
investors with more risk-averse profiles, preference should
therefore be given to investments in diversified baskets of
commodities, to ensure portfolio diversification.
To allow for more secure and/or more diversified access to
these markets, banks have adapted their products and now
offer undertakings for collective investment (UCIs) allowing
diversification of underlying products via composite indices,
or certificates or structured funds indexed to these markets.
Some even offer products guaranteeing the principal amount,
thereby protecting investors from market falls or volatility.

67
 INVESTING IN EXCHANGE-TRADED
PRODUCTS (ETPS)
1 What is an ETP and what are its main characteristics?
Exchange-traded products (ETPs) are a broad category of listed securities tracking the performance of one or more underlying
assets. They encompass exchange-traded funds (ETFs), exchange-traded commodities (ETCs) and exchange-traded notes
(ETNs).

ETP

ETF ETC ETN

Provides access to, inter alia: Provides access to, inter alia:
■ Equity indices
■ Individual commodities (e.g. gold,
■ Commodity indices oil, agricultural products, industrial
Provides access to an asset or
metals, etc.)
■ Fixed income markets benchmark using an uncollateralised
debt security
■ Money markets ■ Commodity baskets

■ Private equity indices ■ Currencies

■ Fund of hedge funds indices

Source: ETF Securities

68
Only ETFs, being funds, can be UCITS compliant; ETCs and ETNs are issued not as fund units but as debt securities. As such,
ETCs and ETNs can never be UCIs under the UCITS directive, and therefore can never be governed by UCITS regulations.
ETFs can be UCITS-compliant funds if they are created and managed in the European Union by a UCITS-compliant asset
manager.
As a consequence, many available ETFs are not UCITS compliant because they are not European or because their issuer has
elected not to conform to UCITS requirements. For example, no US ETFs can be UCITS compliant.
Characteristics of ETPs:

ETF ETC ETN

UCITS (Undertaking for Collective
Legal format Debt securities Debt securities
Investment in Transferable Securities)
Governed by the UCITS directive Possible Never Never

Commodity access Limited Yes Yes

Issuer credit risk Limited Limited Yes

Eligible in a UCITS fund Yes Yes Yes

Source: ETF Securities

69
 1.1 Replication method The principal risk of synthetic ETPs is the risk of counter-
party default, otherwise known as counterparty risk. If a
ETPs can be structured in two ways: physical or synthetic
counterparty defaults on its obligations under the swap
replication.
agreement, the ETP may not be able to provide the return
on the assets it is tracking, potentially incurring losses for
Physical replication investors. To minimise the impact of a default, most synthetic
A physically replicating ETF owns either all or a sample of ETFs and ETCs are backed by collateral.
the assets that comprise the underlying benchmark. This
is known respectively as “full replication” or “sampling
1.2 Performance
replication”.
The purpose of an ETF is to track the performance of an
Full replication underlying index. The standard industry risk measures are
The underlying assets are held in the same proportion as the tracking error (TE) and the tracking difference (TD).
their weighting on the replicated index. This method is used
if the underlying assets are readily available, reasonably Tracking error
small in number and do not significantly change (e.g. the Tracking error (TE) is a measurement that assesses how
102 shares listed on the FTSE 100, reviewed quarterly). closely an ETF tracks an index.

The main advantage of full replication is that since the This enables investors to check the stability of the ETF’s
product holds the same assets as the index it tracks, the tracking ability over time. While volatility reflects the
replication is extremely accurate. However, the disadvantage overall risk for the ETF’s return and is directly correlated
is potentially high transaction costs if the index frequently to the replicated index’s volatility, TE offers an additional
changes a large number of its components. measurement that highlights the replication risk, in contrast
to market risk.
Sampling replication TE is a key indicator for tactical investors who trade ETFs on
Instead of holding all the assets that make up an index, the a regular basis or hold an ETF for only a few days or weeks.
product holds a sample of the index’s components.
This approach may be used if the benchmark contains a How TE is calculated:
large number of assets which change frequently (e.g. the Standard deviation of the ETF alpha:
MSCI World Index, with nearly 300 of its 1,600 securities
TE =√Var (rETF− rbenchmark)
changing every year) or if these assets have low liquidity.
Transaction costs are lower for sampling replication than TE and risks
they are for full replication. However, because the ETP’s There are three main risk factors that may affect and
holdings differ from those of the index, the product’s increase TE:
performance may not be exactly the same as that of the
■ Fees
index.
Higher transaction fees are logically detrimental to alpha
and result in higher volatility.
Synthetic replication
Unlike with physical replication, a synthetic ETP does not ■ Replication method
physically hold the assets on the replicated underlying index. There is no empirical evidence that any given method
Instead, the ETP issuer enters into a swap agreement with a produces a better TE. Each method has specific features that
counterparty that undertakes to pay the performance of the may increase the TE.
underlying assets. An ETP provider might choose synthetic
For physical replication, the rebalancing cost has the biggest
replication for a number of reasons:
impact and can negatively affect the TE, especially for less
Accuracy: because the return on a synthetic ETP is guaranteed liquid indices.
by a counterparty, it can accurately match the performance
Sampling replication may reduce the rebalancing cost for
of the underlying assets.
such indices or indices with a large number of securities;
Cost-effectiveness: a synthetic ETP has limited transaction however, this may generate a gap between the ETF’s
costs relating to the buying and selling of underlying assets. composition and the benchmark, hence creating volatility in
Access: non-metal commodities can only be accessed the TE.
synthetically because of the difficulties associated with Performance-enhancing practices, such as securities lending,
storage. may have a positive impact on the TD, but this may lead to
Diversity: synthetic ETP structures offer exposures that the performance diverging from that of the replicated index.
cannot be physically replicated, including long or short
leveraged products, volatility indices and emerging market
securities.

70
Theoretically, synthetic replication generates a lower TE due 1.3 Trading and valuation
to the nature of the replication process. Nevertheless, this
ETFs trade like shares in that they are listed on equity
does not exclude additional risk factors that may have a
exchanges and are thus traded via standard transaction
direct impact on the TE, such as the swap cost and structure,
tools. However, the liquidity of an ETF differs from that of
which are directly correlated to the weighting and liquidity
a share.
of the replicated index.
■ Cash drag Many investors who are experienced in equity trading tend
to use the screen volume as a primary proxy for liquidity.
The last component is the uninvested cash held in the
The trading volume of an ETF may not reflect its accurate
portfolio due to daily operations. The challenge for a
liquidity level, however, as it not does include the liquidity
portfolio manager is knowing how to reduce the impact of
of the components of the underlying index, which can be
the residual cash balance on the fund’s overall performance.
added as part of the ETF trading process. This is because
ETPs can be created in exchange for underlying assets or
Tracking difference
cash.
Tracking difference (TD) is defined as the total return
difference between a fund and its benchmark index over a Consequently, ETPs can source liquidity from the tracked
given period of time. underlying assets.

For a long-term investor, such as a pension fund or a retail Unlike a share, pricing is not determined by the supply and
investor, the TD between the fund and its benchmark over demand of a fixed number of units because ETP units can
the target investment period (e.g. one or three years) is of be created to meet demand. Instead, ETPs are priced on the
greater importance. basis of the underlying assets. Arbitrage ensures that ETPs
closely track their underlying assets.
Causes of TE and TD:
Cost is the biggest reason for TE and TD. Given that the total
Creation and redemption
holding cost comprises both fixed (total expense ratio – TER,
ETP investors purchase and sell securities on the stock
see section 1.6 below) and variable (bid/ask spreads) costs,
exchange, which is known as the secondary market.
such costs may contribute to an absolute difference between
a product’s return and that of its benchmark (TD), as well as There is also a primary market, on which authorised
a difference in volatility (TE). participants (APs) can trade directly with the issuer of the
ETP.
However, there are other causes of TE and TD:
APs are financial institutions able to mobilise the underlying
Cost factors affecting Non-cost factors affecting assets or cash needed to create ETP units. Only APs can
replication replication create or redeem ETP units. They are typically investment
Dividend banks or specialised market-makers.
Total expense ratio
reinvestment
The latter are financial institutions that quote prices for an
Rebalancing Withholding
asset in order to provide liquidity for it. They aim to profit
costs tax
from the bid/ask spreads.
Swap spread Sampling replication

Tax Securities lending

Sources: ETF Securities

71
 E.g. BNP Paribas Easy APs and market-makers (December 2017):

ABN AMRO HYPOVEREINSBANK

Banca IMI IMC
Barclays Jane Street
BNP Paribas Arbitrage JP Morgan
Citadelle KCG
Citi Group Kepler
Commerzbank Merrill Lynch
AUTHORISED PARTICIPANTS
Crédit Suisse Morgan Stanley
Deutsche Bank Natixis
Flow Traders Optiver
GFI Société Générale
Goldenberg Susquehanna
Goldman Sachs Timber Hill
HSBC Virtu Finance

BNP Paribas Arbitrage KCG

Citigroup Global Markets Morgan Stanley International
Commerzbank AG Optiver V.O.F.
MARKET-MAKERS
4700 Flow Traders Société Générale
Hypovereinsbank Susquehanna Intl Sec LTD
IMC

Creation process
The AP submits an application to the ETP provider to purchase (i.e. create) units.
The AP then delivers the underlying reference assets or the cash equivalent to the ETP provider.
For example, if the ETP tracks the FTSE 100 index, the AP will deliver the FTSE 100 constituent shares according to their
weighting in the index or the cash value of such shares.
In exchange, the ETP provider transfers the same value in ETP units to the AP, which can then sell them to intermediaries and
investors on the stock exchange.
Redemption process
The AP submits an application to the ETP provider to redeem (i.e. cancel) units.
The provider delivers the underlying reference assets or the cash equivalent to the AP. In exchange, the ETP provider cancels
the same value in ETP units.

PRIMARY MARKET STOCK EXCHANGE

ETP ETF unit ETF unit Market-maker

Authorised
provider Cash or participants Cash
reference assets

Broker

Buy/Sell

Investors

72
1.4 Valuation and arbitrage process
In theory, the price of an ETP should be determined by its
net asset value (NAV) divided by the number of units. The
NAV fluctuates according to the price movements of the
underlying assets which, in turn, alter the price of each ETP
unit.
ETCs have no NAV. Instead, the price of a metal ETC is
determined by the number of rights multiplied by the spot
price of that metal. The spot price fluctuates according to
supply and demand for the underlying metal.
If supply and demand for an ETP causes it to trade away
from its NAV value, an arbitrage opportunity arises:
■ If the ETP price is greater than that of the underlying assets,
the AP can buy the underlying assets and exchange them
for ETP units. These units can then be sold to intermediaries
and investors. Since the ETP units are worth more than the
underlying assets, the AP makes a profit.
■ If the ETP price is less than that of the underlying assets,
the AP can buy the ETP units and exchange them for
the underlying assets. These assets can then be sold to
intermediaries and investors. Since the assets are worth
more than the ETP units, the AP makes a profit.
With ETPs, the creation/redemption process allows an
arbitrage operation to take place. The AP can continue the
arbitrage until there is no price difference between the
ETP's NAV and the underlying assets; i.e. until the arbitrage
process is no longer profitable. This ensures that ETPs can
only trade away from their NAV for short periods.

1.5 Securities lending

Securities lending is used in most fund structures, including
index-linked and active funds, segregated mandates and
physical or synthetic ETFs. If carried out in a properly
controlled environment, it is considered a low-risk activity.
However, there may be significant differences in the returns
generated, the risk management standards and the level
of transparency provided in different securities lending
programmes.
For a fund investor, the primary benefit of securities lending
is the extra revenue generated, which in some cases may
significantly offset the cost of holding an ETF. Investors
should consider the additional revenue generated by
securities lending as an important factor when making an
investment decision.
The way in which securities lending is conducted by
various fund providers may differ significantly. It is critical
that providers are transparent about their process, risk
management and revenues generated to give investors the
key information they require to holistically assess the risk/
return profile of the securities lending programme.

73
 1.6 Costs and performance
Cost is one of the most important factors to consider when making an investment. While performance is difficult to predict,
costs are not. Unfortunately, ETP costs are not always transparent.
The most widely reported cost figures are ongoing charges or the total expense ratio (TER), but these are often incomplete if
any internal and external expenses (transactions costs, swap spreads and bid/ask spreads on exchanges) are not included.

INTERNAL FACTORS EXTERNAL FACTORS

> Total expense ratio

PHYSICAL > Rebalancing cost
REPLICATION > Securities lending income > Trading spreads
> Withholding tax > Creation/redemption
TOTAL COST
costs
OF OWNERSHIP
> Transaction fees
> Total expense ratio (TER) > Tax
SYNTHETIC
> Swap spreads
REPLICATION
> Securities lending income
Source: BlackRock

1.7 Key factors to consider when choosing an ETF

Physical Synthetic Physical Synthetic

ETNs
ETFs ETFs ETCs ETCs
Market risk • • • • •
Tracking difference • • • • •
Tax • • • • •
Costs • • • • •
Currency • • • • •
Securities lending (•)
Sampling (•)
Counterparty risk (•)* • • • •
Credit risk •
* = where there is securities lending () = where applicable
Source: ETF Securities

74
2 Why invest in ETFs? 3.3 Liquidity risk
Market liquidity may be limited as a result of:
■ Access to all asset classes. ■ A suspension in the underlying market represented by the
■ Listed on all major exchanges in a range of trading ETF’s benchmark.
currencies. ■ A system failure on one of the relevant stock exchanges, or
■ Immediate market access through a single transaction. with a market-maker or,
■ Cost effectiveness: lower TER than active funds. ■ An abnormal trading situation or event.
■ Simplicity: trades on exchanges like a share. Held in
brokerage or bank custody accounts. 3.4 Risk linked to leveraged ETFs
■ Flexibility: choice of benchmark index, structure, trading
These instruments carry specific risks that investors should
venue, dividend distribution etc. ETFs are used by a wide consider before investing.
range of investors.
Leveraged ETFs are only intended for knowledgeable

3 What are the main risk components that should be

investors who:

considered when investing in ETFs?

■ Understand the mechanism of leveraged ETFs and accept
the risk of incurring substantial losses over a short period
of time.
■ Understand the characteristics and specific features of
ETFs are tracking instruments: their risk profile is therefore
comparable to a direct investment in the benchmark index. leveraged ETFs.
Investors’ capital is fully at risk and they may not recover ■ Monitor their portfolio daily and react to changing market
their initial investment. conditions and the ETF’s performance.
Leveraged ETFs are not intended for risk-averse or
3.1 Replication risk
conservative investors who:
ETFs are designed to replicate the performance of a ■ Are unable to bear the loss of some or all of their capital
benchmark index. Unexpected events relating to the
over a short period of time.
constituent assets of the benchmark may impact the index
provider’s ability to calculate the benchmark, which in turn ■ Are unfamiliar with the characteristics and specific features
may affect the ETF’s ability to replicate it effectively. This of leveraged ETFs.
may create a tracking error in the ETF. ■ Do not monitor their portfoliodaily These types of invest-
An ETF’s benchmark index may be complex and volatile. When ment are generally not designed for a buy-and-hold
investing in commodities, the benchmark is calculated with strategy.
reference to commodity futures, which can expose investors
to risks related to the cost of carry and transportation. ETFs
exposed to emerging markets carry a greater risk of potential
loss than investments in developed markets because they
are exposed to a wide range of unpredictable risks.
Holders of synthetic ETFs may be exposed to risks resulting
from the use of OTC swaps. The counterparty bank arranging
the swap may not be in a position to pay the performance
of the index.
Physical ETFs may be exposed to counterparty risk if there is
a securities lending programme.

3.2 Foreign exchange risk

ETFs may be exposed to foreign exchange risk if the currency
of the ETF or of the underlying assets that make up its
benchmark index is different to that of its benchmark. This
means that exchange rate fluctuations could have a negative
or positive effect on returns.

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 4 Glossary Annualised ETF performance
The performance of the ETF based on official NAV, calculated
over the given period and annualised over 365 calendar
Optimisation and sampling days.
Optimisation and sampling are often the options selected
by ETF providers when full replication is deemed less Tracking difference (TD)
attractive because of total replication costs. Hence ETF The difference between the annualised performance of the
providers will use “optimisers” to select a subset of the ETF, based on the official NAV, and of the replicated index,
index securities, thereby retaining similar exposure and over a given period.
similar risk characteristics to those of the index. While this
practice reduces the cost, it can also cause a slight deviation Worst 1-year cumulative return difference
from the index, which is often mitigated by ETF providers. It This provides a statistic for a 1-year investment.
is important to keep in mind the risk that optimisation can It corresponds to the lowest (i.e. worst) cumulative return
lead to a lower performance than that of the index, thereby difference between the ETF and its underlying index over a
offsetting the gains from lower transaction costs. period of 365 consecutive calendar days, over a given period.

Securities lending Best 1-year cumulative return difference

ETFs can use the assets they hold to achieve additional This provides a statistic for a 1-year investment.
sources of income. The lender is compensated with a fee,
This corresponds to the highest (i.e. best) cumulative return
and the loaned assets must be returned at the end of the
difference between the ETF and its underlying index over a
transaction.
period of 365 consecutive calendar days, over a given period.
ETF providers select a maximum percentage of securities
that can be loaned from the total portfolio, with Tracking error
specific requirements as to the nature of the collateral This indicator of relative risk corresponds to the annualised
and/or the list of securities eligible for lending. Then they volatility of the daily return difference between the ETF and
delegate the transaction management to a lending agent. its replicated index over the given period. The volatility is
Revenue is split between the lending agent and the ETF. annualised over 260 days (daily volatility multiplied by the
It is important to assess all these elements to have a square root of 260).
comprehensive view of the security lending process.
Average daily return difference
Yield enhancement The average of the daily return difference between the ETF
To enhance yield, the fund’s objective is to obtain a favourable and its replicated index over a given period.
withholding tax rate on net dividend returns in comparison
to the replicated index. ETF providers often choose the Worst daily return difference
domiciliation of their funds with a view to benefiting from The worst daily return difference between the ETF and its
local tax rates. For example, most UK providers domicile replicated index over a given period.
their funds in Ireland.
Securities lending can also enhance yield by way of a Market capitalisation
temporary assignment of foreign securities to a local investor The market capitalisation calculated at the end of a given
at the time of dividend payments. period is equal to the total number of available ETF units
multiplied by the official NAV on the last date of the given
Expense ratio period.
The expense ratio includes the ETF costs known ex-ante, i.e.
administration and management fees (on an annual basis). One-month ADV
However, it does not include additional transaction costs or The average daily volume (ADV) of shares traded on the
swap fees (in the case of synthetic replication). market during the previous month.

Annualised index performance Your BGL BNP Paribas advisor is available to provide any further
The official performance of the index tracked by the ETF, information you may require, to supply you with BNP Paribas’ ETP
calculated over the given period and annualised over 365 investment recommendations, and to assist you in your choices,
calendar days. according to your personal needs and investment profile, before
any investment decisions are made.

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Disclaimer
This documentation has been issued by BGL BNP Paribas As this documentation inevitably presents a product/
for the exclusive use of the person to whom it as been service or a range of products and/or services in a
given, either directly or under a power of representation; summarised and abbreviated manner, any interested
it must not be distributed, published or reproduced in person should consult and carefully examine all available
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written approval of BGL BNP Paribas. required, put any questions relating to the product/
service to a BGL BNP Paribas representative in order to
Receipt of this document does not constitute the opening
gain a full overview of the prerequisites, characteristics
of a business relationship. This document has been
and potential risks of the product or service envisaged
supplied solely for information purposes, and does not
and, if necessary, should consult his or her personal
under any circumstances constitute an offer, marketing
advisors. Any interested person is once again strongly
approach or solicitation of any kind, particularly in a
advised to note and gain an understanding of the risks
country or jurisdiction in which such an offer, marketing
and obligations involved in any product that is of interest
approach or solicitation is not authorised, or to persons to
to them. They should ensure that they have sufficient
whom such an offer, marketing approach or solicitation is
knowledge, understanding and experience of these
illegal. This document, in whole or in part, is not intended
risks in order to prepare their own detailed analysis of
to constitute the basis for any agreement or commitment
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and must not be considered in any jurisdiction as a
considered.
prospectus, in whole or in part, or an offer, solicitation,
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investment of assets or structured products. to the prior signature of specific agreements detailing
the operating terms and conditions, the supply of a
In any event, it is recalled that the opening of a business
product or service included in this information brochure
relationship and the sale or offer of a product or service
may require a business relationship to be opened with
may be subject to restrictions, based on the domicile and/
BGL BNP Paribas thus requiring the prior and
or nationality of an investor, and may not therefore be
subsequent fulfilment of certain conditions and
authorised or made available to certain persons.
requirements, notwithstanding acceptance at the
discretion of BGL BNP Paribas. The reader’s attention
is also drawn to the fact that upon opening a business
relationship, subscribing for a service or performing
a transaction in a product, the involvement of
BGL BNP Paribas is subject to fees or commissions, which
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is available upon request and may be subject to change
over time.

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