A few intriguing questions popped up in my mind as I was looking through the prospectuses of a few structured products last weekend. You may well ask what kind of a saddo would do such at weekends, when s/he could be watching a football match, meeting friends in the pub, doing some useful home improvements or even reading something a tad more interesting. As for why I had a bunch of structured product prospectuses to hand, I donâ€™t even want to go there. But I digress.
In many countries, investors are very enthusiastic about structured products. They can be used to gain exposure to exotic and sometimes risky financial instruments while at the same time limiting the risk. For example, a large part of the investment may be allocated to risk free instruments in order to guarantee the initial capital, with the remainder invested in an underlying asset with a much higher risk-reward profile, often using leverage.
Germany for example has a huge market for hedge fund-based structured products simply because it is so difficult for Germans to invest directly in the real thing. The rules on tax transparency limit the type of hedge funds that clients can invest in, and also limit the instruments that funds looking to be considered as tax transparent can invest in, as well as precluding leverage and limiting the use of derivatives. Structured products have no such limitations, and can have underlying funds that would not be considered tax transparent in the case of direct investment.
Problems can occur if the risky asset performs badly at the beginning of the investment period, especially if leverage is used, since this can eat up the entire allocation to the â€śriskyâ€ť part of the portfolio. In this scenario, the customer has to wait until the term of the structured product is complete in order just to get the initial capital back. It is a question of timingâ€¦ but that is another story.
Getting back to the prospectusesâ€¦ One of those that caught my interest was Man Groupâ€™s â€śMan Multi-Strategy Series 6â€ť. As the name suggests, this product is structured on a portfolio of hedge funds. It is a capital protected fund with a term of 13 years which guarantees a minimum return 120% of capital on expiry. There is a 150% allocation to funds managed by Man, 48% of which is in managed futures programs, including a large allocation to the firmâ€™s flagship managed futures fund AHL. The capital guarantee is achieved through an allocation to zero coupon US treasuries, hedged for interest rate risk in the dollar class, while the euro class uses euro-denominated bonds or bank deposits.
Clearly, a 120% return after 13 years is a worst-case scenario, which would occur if the underlying hedge fund portfolio did not perform at all. Presumably, if the risk capital allocated to this portfolio falls below a pre-established level, it is liquidated and the remaining capital allocated to risk-free securities to ensure the minimum 120% return, which is guaranteed by ABN AMRO. As with most structured products, notes cashed in before expiry do not enjoy a guaranteed return.
The Series 6 version launched in 2003 stated that its objective was an annualized return of 15% to 17% net of fees, and volatility of 10% to 12%. There is no subscription charge.
A similar product is offered by Dublin-based Lawrence Life Assurance Company Limited. In fact, from the prospectus it appears that the firmâ€™s â€śSkelligâ€ť range of products has Man Multi-Strategy Series 6 as the fund portfolio underlying these products. Lawrence Life is a subsidiary of Italy-based Fondiaria-SAI SpA, one of Italyâ€™s largest insurers.
When SAI bought Fondiaria some years ago, it was condemned by Italyâ€™s then toothless regulator Consob for the way in which it had forced through the transaction. That was achieved, in effect, via the expedient of loading the Fondiaria board with SAI-friendly directors after SAI had built a large stake in its smaller but more efficient rival. The directors who approved the SAI offer certainly didnâ€™t seem to have the interests of Fondiariaâ€™s minority shareholders at heart. But again, I digress.
The product offered by Lawrence Life has a 7% front load for subscriptions between the 20,000 euro minimum and 50,000 euro. That drops to 6.1% for subscriptions over 50,000. It doesnâ€™t seem particularly generous, especially when one considers that the underlying product has no front load at all. Further, one distributor suggested that Lawrence Life is accorded a 0.5% distribution fee from Man. 7.5% just for selling the product? Nice work if you can get it.
But that is not all. The product structured on an already-structured product charges a 1% annual management fee, which makes another 13% over the life of the note. Finally, horror of horrors, the original Man product guarantees a minimum return of 120% of capital on expiry of the notes, while the impostor guaranteesâ€¦ 104%!!!.
Now, I cannot say I am a huge fan of structured products, but I recognize there are some very good ones out there that are cleverly tailored for the needs of a certain type of investor. But I cannot say the products offered by Lawrence Life are among them. I emailed the firm, inviting them to explain their exorbitant front load, what they do to justify their management fee, why 120% capital guaranteed in the original product turns into just 104% for their end clients. Answers came there none. As yet.