| Alternative Structured Products 101 |
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| 22/08/2004 | |
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Alain Dubois of Lyxor Asset Management answers this week's 101 on alternative structured products. What is an "alternative structured product"? Over the last couple of years, the demand for structured products has grown significantly as a response to uncertain market conditions and investor needs, which traditional investments cannot satisfy, such as: - (Full or Partial) Protection of capital or certain performances - Diversification of returns in a variety of market scenarios (falling, u-shaped, irrational markets, etc) - Enhanced exposure via leveraged products Rather than investing directly in the underlying assets (such as shares, bonds, mutual funds, etc), structured products use derivatives in order to provide synthetic exposure to a given underlying. As such, they can determine a precise return profile for a given investment period according to the individual risk/return profile of the investor, in contrast to traditional investments, which are dependent on the skills of a specific asset manager and whose returns are unpredictable. "Alternative Fund Structured Products" are a further step in the development of structured products linking the performance of the structured product to hedge funds rather than the traditional equity or bond markets. As such, they provide investors with the opportunity to benefit from the flexibility of structured products combined with the advantages of alternative investments within well-established risk parameters: - Absolute rather than relative performance targets allowing more flexibility compared to benchmark constraints of traditional asset managers - Control of volatility - Low correlation to the traditional market movements What are the alternative underlying assets that can be used to structure such a product? Exposure to the underlying hedge funds can be obtained through collective offshore funds or through dedicated managed accounts. Managed accounts typically offer a better risk environment (transparency, higher liquidity, control over the assets and the valuation process), while products based on external hedge funds offer a larger investment universe. Similar to traditional structured products, alternative structured products can be created on single hedge funds, passive baskets of hedge funds, and actively managed portfolios of hedge funds according to the risk/return requirements of the investor. Additionally, index providers have recently teamed up with investment banks' managed account platforms in order to provide index solutions. The objective of investable hedge fund indices is to enable investors who are not familiar with hedge funds to gain exposure to the asset class without the need to select individual managers, all the while benefiting from the sort of liquidity to which they are accustomed. What are the main advantages and risks associated with such a product for an institutional investor? The risk/return balance can be tailored according to the investor's needs as well as his own anticipation of market developments. The stream of cash-flows can be adjusted to best suit the individual liquidity requirements, i.e. guaranteed regular coupons throughout the investment period, increased coupons at the beginning or rather higher payments at the end of the investment period, etc. As such, these products provide access to new sources of performance optimising the risk/return profile of investors and responding to constraints of asset/liability management. Nevertheless, the desired pay-out is normally only guaranteed at maturity which means that it is recommended for the investor to remain invested until maturity in order to achieve his investment objectives. A secondary market usually exists for these products, but prices will depend on interest rates, volatility, and the remaining time-to-maturity due to the characteristics of derivatives. Liquidity will differ according to the underlying and the product but leading providers will normally give monthly to weekly liquidity with a tight bid/offer spread. |
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Articles of the same Serie : 101 |
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Articles of the same Topic : Derivatives |
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