Derivatives houses are starting to write capital-protected products on single hedge funds as European fund investor education increases and margins on multi-fund structures are squeezed. Although some single-strategy instruments were written last year, it was chiefly the domain of the most aggressive fund derivatives houses because the operational risk and volatility were deemed too high by the mainstream product providers. ABN AMRO, Deutsche Bank and Barclays Capital have all closed deals this year and other houses, including Credit Suisse First Boston, Merrill Lynch and Goldman Sachs, are looking to start ramping up their fund-linked offering.
"We are being asked for single strategy fund products on a steadily increasing basis," noted one fund structurer at a top-tier U.S. house. There is demand from investors to buy the products as well as an increasing appetite from the banks to structure the deals, he added. Onno Vriesman, head of securitized products at Deutsche Bank in London, said the increasing sophistication on the part of hedge fund product investors is leading to more tailored products. Initially investors were looking at hedge funds in general, but now there's a lot of focus on specific hedge fund sectors, he explained.
Matthew Judd, partner at Clifford Chance in London, said he has seen his first two products linked to single hedge funds in recent weeks. There is also interest from the hedge funds, according to Judd, who explained capital-protected notes written on their funds allow them to raise capital from a wider range of investors.
Donald Leitch, head of European equity and fund-linked structuring at Merrill Lynch in London, said, "A lot of people in the market are looking at this." But he added, "There are some fairly significant issues with getting comfortable with the risk."
Most deals so far have been CPPI on managed accounts held with the structuring bank, such as BlueBay Asset Management's capital protected bond fund products (DW, 3/7). Managed accounts give the bank a better opportunity to handle its exposure to the fund. One structurer, however, noted houses with strong prime brokerage arms may start to use prime brokerage agreements and systems to write protection on the funds they service. This could counter the dominance of European houses with managed account platforms, such as SG Corporate & Investment Banking with its Lyxor Asset Management platform.
