Bridging the product gap

Investment banks are attempting to build bridges with private banks, which are seeking new ways of satisfying high net worth individuals as the performance of traditional products weakens. High net worth individuals (HNWIs) and the private banks that manage their funds are looking for new ways to reach their investment targets. Traditional products aimed at HNWIs, such as equities and equity-linked notes, are no longer generating stellar returns, turning private banks’ attention (as is happening with most other investor classes) to fixed income products. Recent product developments in the fixed income markets mean investors now have more choice than ever before, with offerings tailored to achieve their specific investment goals. New products, such as credit derivatives, collateralised debt obligations (CDOs) and hybrid credit/interest rate products, are fuelling explosive growth in the fixed income markets. For private banks, it is fundamental to gain access to fixed income products in a format which meets their clients’ legal, regulatory, tax and accounting requirements while generating the required returns. Investment banks are focused primarily on servicing the needs of institutional clients such as banks, insurance companies, fund managers and corporates. This is especially true in the fixed income markets, where traditional product offerings (bonds and swaps) trade in large size. The key, therefore, is for investment banks to bridge the gap by offering private banks fixed income products tailored to their unique client base. While this is already happening, private banking has only been exposed to a small segment of the product range. Recently, there has been increased placement of products such as traditional CDOs and alternative asset CDOs with HNWIs (see CDO article, page 20). However, these products were originally tailored to accommodate the needs of a very different client base. A prime example of a product that is tailored to the private banking client base is the principal protected hedge fund of funds. This not only gives exposure to a number of hedge funds, providing diversification and reducing risk, but – with a capital guarantee embedded – it also repays the investor’s initial investment outlay, regardless of the performance of the hedge funds. Such a principal protection can limit all or part of the investor’s downside risk. Bespoke services To address the specific needs of private banks, investment banks now employ teams of professionals to create tailor-made structured credit and alternative asset products. To meet client requirements, these teams use risk transformation technology, applying techniques such as securitisation and repackaging, to transform assets and cash flows. Banks that issue structured notes off a medium-term note (MTN) programme can link these liabilities to a number of risks on their balance sheets. These are risks that HNWIs would not be able to purchase in their raw format (for instance, swaps, receivables and options). However, once formatted as a simple MTN, with a listing on an EU exchange and Euroclear-eligibility, HNWI investors are able to access a more tailored investment vehicle. Key to success The investment banks that wish to have a successful relationship with private banks must offer a complete product range and need to understand the specific needs of this market. It is not sufficient to be market leader in sourcing and structuring the underlying risks (such as credit, interest rate, foreign exchange and commodities). The investment bank should complete its product offering by solving regulatory, tax, public distribution, order-routing, market-making, documentation, settlement and mass-marketing issues. The World Wealth Report 2001, compiled by Ernst & Young, finds that global HNWI investments in specialised products – which include structured products and alternative investments – are poised to increase significantly during the next three years. As banks step up their efforts to access the private banking client base, there will be increasing focus on the importance of tailoring fixed income products to meet client needs. The next eight pages contain product providers’ breakdowns of the applications of hedge funds, CDOs and convertibles. Stephen Stonberg is managing director of the risk transformation group at JP Morgan Securities