It appear to me that not all MiniBond investors are risk adverse. From forum postings etc, it appear to me that most of these investors are willing to take some risk. The problem in this fiasco is that investors were misrepresented the risk. Many investors thought that:

• They are investing in the bonds of the “Reference entities” typically 6 or 7 well-known companies
• If one of the companies collapses, the investment should drop in direct proportion. This means if there were 7 of such companies and that if 1 collapse, investor thought that their capital lost will be 1/7. Similarly for the entire capital to be lost, 7 out of 7 must collapse.

Unfortunately this is not the case because the MiniBond invested in derivatives such as swaps and CDOs. Many investors thought they were investing  in a fund that invests in plain vanilla bond. If there is such a fund that invests in plain vanilla bond, it implies it will sell like hot cakes afterall this is what many investors will be willing to buy.

Thus I suggest fund managers to create such product:

• A fund that invests in well known of say 5 strong companies
• Bonds of these 5 companies should have similar maturity dates
• This fund should be closed-ended. This means it will mature on the same date as these bonds.
• Coupons paid out of the bonds are to be given to the investors less expenses.
• It is theoretically impossible for all capital to be lost because bond holders have a higher priority to the assets of the companies ahead of shareholders. So even if a bond default, there should still be some assets left over.

Such a fund is not the same as the traditional bond unit trust. A bond unit trust has two problems – it is actively managed and hence will underperform on a long run and secondly it has no well defined maturity date. The fund manager can liquidate the underlying bonds before maturity.

Why fund managers are not keen in creating such product since there is such huge market for it? Perhaps the reason has to do with very low commission. Currently risk-free SGS Bond over 5 years is 2.42%pa. For a company bond it will have to trade at a premium say 5%pa.  The fund manager also need to feed the distribution channel of say 5% upfront fee (if amortized using simple interest over 5 years it is equivalent to reduction in yield of 1%pa). The fund manager also need to charge 1%pa. Therefore the expense ratio is 2%pa. End of the day the net return is just 3%pa for 5 years.  This will not be attractive to investors. So either the commission has to come down or the fund manager must seek a higher yield investments. That’s why CDOs, derivatives and exotic now known as toxic waste is being sold instead of plain vanilla bond.

If there is a way to have the expense ratio 0.5%pa and if the AUM of such simple product is $500 million, than the product manufacturer will earn 0.5%pa * 500 = $2.5 million yearly for 5 years. Not bad right? Any businessman want to joint venture with me to do this? :)