As the UK market ponders whether hedge funds will form the next major linked asset for structured retail products, news from around the world suggests that they might.
UK
In the UK, the FTSE group has teamed up with MSS Capital, to launch the Cayman Island FTSEhx Fund SPC, whose constituents will form the basis of the FTSE Hedge index series. Following a model already established by the S&P in its investable indices, the fund and its index is designed to replicate the risk-return characteristics of the broad hedge fund universe. Due diligence is provided by Harcourt, a well known name in the hedge fund field.
Investments are possible at three different levels in 12 share classes listed on the Dublin Stock Exchange. A global share class invests in all of the 40 constituent hedge funds. Three style-based share classes divide the universe up into directional, non-directional and event-driven sectors, each consisting of around 10-20 hedge funds. Eight trading strategy-based share classes consist of between 3 and 12 funds.
There is an initial charge (rebateable) of 3%, and a bundled annual charge of 1% covering both investment management and FTSE licence fees. The fund offers monthly liquidity without exit penalty for a minimum subscription of US$500,000.
According to MSS Capital founder Mark Ellis, the FTSEhx Fund SPC is fully customisable and is intended to appeal not just to institutions and pensions funds looking to invest in a transparent fund of hedge funds, but also to retail product providers looking for a credible index upon which to construct products.
Global trends
Structured products are already proving a hit with institutional investors in hedge funds themselves (institutions being defined as financial services institutions, as well as pension funds and insurance companies) and likely to grow further, according to Deutsche Bank’s annual alternative investments survey.
Thirty two percent of the 323 institutions surveyed (representing $380 billion in hedge fund assets) said that they were using structured products as a means of gaining exposure to hedge funds. Almost half of the 68% that did not use structured products said they intend to use structured products in the near-term. The most prevalent use (almost 41% of respondents) was to gain leverage. The second highest use was for principal protection; 23% of respondents used structured products for hedging against market loss.
As further indication of this trend, HFR Asset Management LLC in Chicago has announced that assets under management have reached US$2 bn, in large part due to structured products.
Investors from Asia, Europe and the US, including major banks and brokers, are using Hedge Fund Research funds and indices as the basis of structured products, including principal-protected notes, options, warrants and total return swaps, according to HFR chief marketing officer Bill Santos, reported in the Structured Products Association newsletter.
North America
Meanwhile, the National Association of Securities Dealers has allowed hedge funds and hedge fund-structured products to use back-tested numbers in their marketing literature, provided the member ensures that all recipients of such sales material are ‘qualified purchasers’ with minimum net worth of $5m under Section 2(a)(51) of the Investment Company Act. According to Structured Products Association president Keith Styrcula, “’Related performance’ figures are acceptable as long as there is substantial and conspicuous language that describes the methodology for calculation.”
So far, only Canadian houses undertake a concerted effort to market hedge fund-based structured products to retail investors. For example, Arrow Hedge Partners, a fund of fund managers with US$200m under management based in Toronto, Canada, regularly issues capital-protected notes. Its most recent offering is the Arrow Multi-Strategy Hedge Fund note, guaranteed by BNP Paribas, which allocates to 20-25 hedge fund managers across a diversified set of strategies. Minimum investment is C$5,000, in a Canadian tax-efficient vehicle. The fund has an annual absolute return objective of 7-9%.
Europe
In Europe, French investment bank CDC IXIS has partnered with the European subsidiary of Chicago-based Hedge Fund Research to develop worldwide structured products based on HFR’s investable hedge fund indices for various international markets. It has entered into a license agreement for Asia and the Middle East with another arm of HFR and begun to structure products for Asian clients according to company officials. The bank provides hedge fund-linked structured notes.
The HFR index set comprises eight hedge fund strategies – convertible arbitrage, distressed securities, event-driven, equity hedge, equity market neutral, macro, relative value and merger arbitrage.
