Planning the perfect product

Identifying the next top-performing asset class, the most profitable

industrial sector or the region with the best potential for growth is

only the first step of the product development process. Designing

wholesale products that will allow investors to access those markets,

and adapting them for each separate distribution model is what can

really make the difference for a manufacturer or distributor.

Distributors looking to set up a comprehensive buy-list may appear

spoilt for choice. After all, they have access to traditional European,

US and Asian equity classes, absolute return, private equity, the more

colourful fixed income strategies such as high yield, and exposure to

emerging regions.

But in reality, it is a small number of sectors that are driving

performance, leading to a re-think in asset allocation philosophy and

the types of products that are chosen for private clients. The

disappointing performance of the equity markets in recent years has

forced asset managers to look for different and more sophisticated

investment vehicles where risk management and portfolio diversification

are crucial. And, building the new breed of product in a way to allow

the manufacturer and distributor to skim off enough fat while leaving a

meaningful return for the investor is possibly the greatest challenge

faced by the industry.

Returns vs charges

“We have to ask ourselves – where is the retail value proposition

today?” says Alan Brown, group chief investment officer at State Street

Global Advisors, responsible for investing assets of $1,100bn (e900bn)

“In a world of double-digit returns you could take 5 per cent upfront,

charge 1.5 per cent per annum and another 1 per cent of transaction

costs and still leave something on the table.

“But in a world of single-digit gross returns you can’t levy those

charges and leave anything worthwhile for the investor. How can the

industry respond?”

It is a challenge to which product design boffins have not been slow to

rise. They have wheeled out their latest risk control models, regional

databanks and asset class experts to be one step ahead of the

competition.

Or they are able to delve deep into the product store, and dust down,

adapt and re-market some old favourites which have come back into vogue

due to changing economic conditions.

Credit Suisse Asset Management (CSAM) uses both these approaches, as it

has a huge incentive to stay ahead of the pack. It manufactures for a

captive internal private banking channel, for an increasing army of

internal distributors and has a huge institutional franchise from which

the best strategies can be adapted.

Its analysts and asset managers have also been keeping a watching brief

on latest economic developments in Europe, so they are ready to move

quickly when the opportunity presents itself.

One of these opportunities is the accession on May 1 of eight new

countries – the Czech Republic, Estonia, Hungary, Latvia, Lithuania,

Poland, Slovakia and Slovenia – to the European Union. Along with Malta

and Cyprus, these nations will boost the EU from 15 to 25 members.

Although their economies have already converged, their accession could attract more interest from investors.

“There are four ways to invest in these regions that are very

attractive propositions,” says Jana Benesova, director and fixed income

portfolio manager at CSAM, giving an insight into how the product

design decisions are made.

Benesova: four ways to invest

“The first one is to invest into fixed income funds that benefit from

all the movements that are part of the convergence process.”

This ground has been previously covered by the Credit Suisse Bond Fund

Emerging Europe (Lux), which has attracted E162m, invested in debt

securities primarily issued by governments, government agencies and

corporations in Central, Southern and Eastern Europe.

Now the fund is once again being pushed through the distribution channels, as the EU enlargement story reaches its climax.

Heaviest weight

Benchmarked against the Merrill Lynch Emerging European Government

Bond index, the cross-border fund has its heaviest weightings in

Poland, Hungary and the Russian Federation, concentrating on bonds with

a maturity of up to five years.

“The second proposition,” says Ms Benesova, “is to invest in a Central European equity fund.”

“But people should take into account that some of those funds include

Russia and Turkey in their benchmark, so investors need to be aware

that they are also buying into a region which is not converging,” she

warns.

“The third proposition is going into the real estate market, which I

think is very attractive but again there are legal differences across

the countries that need to be taken into account. Finally, the fourth

option is to invest in private equity in the region and you can find

several firms that are looking into that.”

The New Europe Emerging Cities fund, launched in February by UK firm

Guardian Managers is an example of the real estate opportunities in the

region.

The initial focus is on investments in commercial property in major

cities in Central and Eastern Europe, particularly within new EU member

states, but the fund will also consider opportunities in Romania,

Bulgaria, Serbia, Russia, Greece and some principal cities in the

former East Germany. Designed for investors seeking a longer term

holding, the fund aims to attract interest from private banks and

insurance companies, as well as larger retail investment portfolios.

Areas of activity

London private client house Cazenove sees these property-based

products as an increasing area of activity for wealthy investors, along

with uncorrelated investments, such as hedge funds in particular. It

has created two relatively low-risk long-short funds and is debating

how to adapt its Absolute Return Fund for Charities, a low volatility

multi-manager fund advised by Fauchier Partners, which gained 12.3 per

cent last year, for high net worth clients.

One way of doing this is to add a guarantee for clients weary of years

of poor equity returns. Man Investments, the world’s largest hedge fund

player, has been developing products that invest across different

investment styles, aiming to achieve portfolio diversification with

guaranteed returns.

Launched in February, the portfolio of the Man RMF Multi-Style fund

consists of five complementary hedge fund styles – equity hedged, event

driven, global macro, managed futures and relative value – with the aim

to perform independently of traditional stock and bond investments.

James Jacklin, senior manager at Man Investments, explains that the

strength of this new investment vehicle is its potential to add

diversification and enhance risk/return profile of investors’

portfolios.

Return guaranteed

The protection structure guarantees a return of at least 100 per

cent of the initial investment on maturity, and a profit-lock feature

offers the potential to elevate the guarantee level at maturity by

locking in a proportion of net new trading profits, following periods

of sustained profitability.

Jacklin: protection structure in place

“The fund is available for both institutional and private investors and

it’s the first of the four structured products we will be

launching throughout the year,” says Mr Jacklin.

Leading European funds house DWS has been quick to adapt hedge funds

for the domestic German market. This is in response to German

regulations driven by a political decision, at cabinet level, intended

to boost long-term investments.

DWS is using the New York arm of parent company Deutsche Bank to run

single manager hedge funds, and to help select 30 underlying external

advisers for its multi-manager offering.

Competitors, including Swiss banks, have been reluctant to enter this

potentially lucrative market due to onerous transparency requirements

of the German regulators. There has long been a bizarre tradition among

private banks where not just positions but even names of underlying

managers are kept secret from clients.

“We cannot produce 30 strategies internally,” says Axel Benkner, chief

executive of DWS. “So we need to appoint external managers, which

necessitates research and evaluation. So that we can access 30 managers

in different companies in a short period of time, we use Deutsche Bank

as our co-operation partner.

“We will not have a problem with transparency,” says Mr Benkner. “We

have never faced a group who did not want to share information with us.

This is because they want to sell their funds. They see us moving ahead

and selling funds in billions, so they are prepared to do the admin

work. We treat data confidentially and will not abuse it for

front-running.”

Tools for managing risk are also becoming more sophisticated and

efficient, and are now essential for fund managers, distributors and

clients.

Risk model

Goldman Sachs has gone a step further by developing its risk model

in line with its CORE (computer-optimised, research-enhanced) strategy.

Now it is targeting distributors with this institutional-style strategy.

Brown: institutional-style strategy

Melissa Brown, managing director at Goldman Sachs Asset Management’s

global quantitative team says: “Our CORE risk model reacts more quickly

to changing levels and sources of risk by using daily returns as

opposed to monthly returns. We think it estimates the risk in our

process more accurately because it takes into account factors which are

specific to our investment process.”

A good example of their CORE investment products is the GS US CORE

Equity Portfolio fund that managed to attract more than $700m in 2003,

now boasting $1bn assets under management. Its European equivalent, the

GS Europe CORE Equity Portfolio, has also been successful in 2003,

attracting over $130m in assets. Currently the fund has a size of

$207m. The funds follow strategies which combine traditional investment

management practices with quantitative criteria.

de Vijlder: trust is most important

“Theoretically, there is always the danger that a product is designed

for the benefit of the house, not the client,” admits William de

Vijlder, chief investment officer responsible for over E80bn at Fortis

Investments in Brussels. “What is of the utmost importance is that the

relationship with clients is based on trust, and identifies issues and

solutions. It should not be a case of ‘I have this product, and you

have to buy it.’ Solutions must relate to the risk exposure of clients.”

A love story to warm the hearts of investors in Bollywood films

The private equity market has been targeting high net worth individuals

for some time, but when new investment proposals come with the magic

“tax relief” tag attached to them, the attraction can be instant.

In the UK, a new scheme has been launched to invest in the booming

Bollywood film industry. The scheme, Motion Pictures Partners

International (MPPI), is a series of partnerships established to

provide up to Ł34m for the production and acquisition of the UK/Indian

films while creating tax incentives for its partners.

MPPI is working on the production of 10 films currently being made in the UK and India, using facilities in Leicester.

Tax relief

MPPI will use secured borrowing to leverage partners’ capital, allowing

funding of more films, and providing partners with an increase in the

initial tax relief available from 40 to 140 per cent of their capital

contribution. In order for the films to qualify for tax relief, a

minimum of 70 per cent of the total budget should be spent in the UK.

Rajeev Saxena, founding partner at MPPI, says: “This is a fantastic

opportunity for UK investors to participate in the most vibrant film

market in the world. New structural developments such as the increase

in multiplex theatres and the emergence of cable TV have increased

access in both the Indian domestic market and for the non-resident

Indian population.”

He says MMPI has managed to attract interest from wealthy investors through independent advisers and “personal contacts”.

“Together with the up-front tax relief, minimum guaranteed revenues and

potential for additional profits, MPPI offers a very attractive and, to

our knowledge, a unique combination for partners,” believes Mr Saxena.

“The Indian economy is booming and this is having an impact in

Bollywood movies and local communities in the UK. Under the scheme,

tax-payers become co-producers of films in an industry that is becoming

more westernised.”

New rules

The MPPI initiative comes against the background of an announcement

from the UK Inland Revenue about the introduction of new rules to avoid

tax relief abuses in some film partnerships. MPPI’s scheme type will

not be affected by the new rules, but other film investment schemes may

have to change the way they develop in the future. For the time being

at least, Leicester remains the UK’s capital of Indian entertainment.