capital protection restricts Funds of hedge funds to more liquid assets, says Absolute CEO
Capital protection structures on funds of hedge funds are restricting the range of underlying investments to more liquid and cautious assets, according to Christopher Aldous, chief executive officer at Absolute Fund Management.
Fund of funds managers are often required by banks, which have created the capital guarantee structure, to have a daily value on their underlying investments to track fund performance closely.
This, Aldous said, could mean investing more heavily in liquid strategies and being more cautious about investing in funds with other approaches.
He added: 'It is easier to deal with the more liquid, long/short and classical convertible bond products than strategies such as distressed debt, where getting daily pricing may be difficult.
'There are some fantastic opportunities in distressed debt at the moment, especially if played via capital arbitrage, but most of the managers we use in this area would be unwilling or unable to provide the real-time pricing required by certain structured products.'
Omar Kodmani, chief executive at Permal Investment Management Services, said some underlying managers, often from distressed debt and global macro strategies, refuse to give the weekly or even daily pricing information needed for protective wrappers.
He believes the way to obviate this is to secure agreement from those providing guarantees on different levels of pricing and information provision.
'The banks may need to accept this will be sacrificed for the benefit of investors,' he said. 'Some accept this, others don't and are more doctrinaire. The ones that make exceptions tend to be more open-minded about creating quality products.'
Kodmani most often uses SociÃ©tÃ© GÃ©nÃ©rale for protective wrappers.
Charles Hopkinson-Woolley, Deutsche Bank's director of global equity derivatives and structured products, said the group uses managed accounts rather than direct investments in hedge funds for its own protected products. This helps it facilitate the provision of asset values daily, and monthly liquidity on five days' notice, from underlying managers.
He believes it is possible to find distressed debt managers offering liquidity weekly and global macro managers offering it daily but it is important the investment process is not altered too greatly by this.
Deutsche Bank tends to stick to strategies with more liquid assets and to flagship funds for its protected products, according to Hopkinson-Woolley.
According to Aldous, structured product managers need to monitor the performance of underlying funds in real time, or at least on a daily basis, and usually require their investments to be in managed accounts with full transparency.
Furthermore, structured products normally require the manager to liquidate hedge fund holdings and reinvest in bonds to meet the guarantee obligations.
Aldous noted protected products also carry the disadvantages of being expensive in terms of fees, which will 'severely impact long-term performance of many schemes'.
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