Through innovation in terms of both product structuring and market access, Barclays Capital has successfully established itself as a leading player in the fund-linked derivatives business. Since setting up its fund-linked business in 2000, when the initial focus was on issuing structured products linked to traditional mutual funds, the bank has expanded its offerings to encompass a range of funds of hedge funds and specialist hedge funds. This year, BarCap has gone a stage further to offer notes linked to private equity and algorithmic trading strategies.
The bank has been particularly successful in working with third-party asset managers to structure protected fund-linked products that largely leave the manager in control of the underlying investment strategy. One of the big challenges for structured product issuers since the rise of derivatives-based investments in the 1990s has been how to market their wares to asset managers without the latter feeling that their 'value-added' is being taken out of the equation. BarCap's hedge fund-linked business, however, has come up with a way to sell its structuring ability alongside the asset manager's portfolio management and alpha-generating expertise.
The process began when the bank worked with a Scandinavian third-party distributor to design a constant proportion portfolio insurance (CPPI) product linked to an externally managed basket of funds that would let the latter's asset management arm manage the underlying basket of funds but also adjust the protection mechanism through a systematic algorithm. BarCap embedded the underlying basket of funds in a managed account that allows clients to determine the weightings of different fund components, subject to investment guidelines specified by BarCap. "First, the underlying funds in the active basket are all managed by the client's asset management arm. Second, the client can change the weighting in the basket and, over time, introduce new funds or remove existing funds, and so on. Third, they implement the CPPI allocation subject to certain limits set by Barclays," says Antti Suhonen, the bank's head of fund-linked derivatives structuring.
The underlying basket of funds consists of both funds of hedge funds and mutual funds, giving exposure to the Nordic equity markets, emerging markets and broader, more established global equity markets. The product is designed to give the asset manager as much scope as possible to add alpha through its trading and risk management expertise. The CPPI mechanism allows for potential leverage of up to 200%. "We set the maximum allocation at any time, so the client can allocate as much as they like to the active asset subject to that maximum allocation constraint," says Suhonen. "It gives them the ability to steer away from the purely formulaic application of CPPI.
The bank has also been working to give investors access to sharia-compliant investments through its third-quarter tie-up with Islamic hedge fund Shariah Capital. The two firms have set up the Al Safi Trust, which is a portal through which financial engineers can mix and match sharia-compliant funds, including long-short and market-neutral hedge funds. Engineers can choose their preferred fund mix and then package it in the structured product format they need.
BarCap is also busy expanding its fund-linked business to give relatively small-scale investors derivatives note-format exposure via structured notes to the types of private equity funds usually out of their reach. For example, the Alpha-Supported Private Equity Note (Aspen), which was launched in the early part of this year, is the first globally syndicated private equity fund-linked note, providing exposure to a portfolio of five private equity funds. "The real cutting-edge private equity managers have historically only been accessible to very wealthy investors with a lot of capital to commit," says Suhonen. Aspen aims to widen that access.
The notes have an expected maturity of 10 years, although at the behest of the underlying funds this can be extended to 14 years. Investors in the notes receive a guaranteed 4.5% annual return for the first five years before the note starts to pay down and return capital and profit depending on performance. The minimum investment is set at $50,000, and the notes were distributed across Europe through a private wealth manager.
Private equity investments usually involve a small number of big players making a number of capital commitments over a period of years then subsequently realising a profit. In general, private equity managers do not deal with many relatively small-scale investors because of the redemption risk, as well as the regulatory, cash management and operational difficulties. With Aspen, BarCap takes investor's cash and invests it in an absolute return fund. This money is then disinvested as the private equity groups request capital.