COMBINING EXPERTISE

Investors often contrast traditional asset ­management and structured management ­universes. While the two approaches offer ­different characteristics, it is precisely such differences that make them complementary assets. This combined approach helps to avoid counter-cyclical investing and, in the current environment, limits equity fund ­redemptions. Indeed, it explains the success of fund-linked structured products in 2007. Traditional active management Traditional management has tried-and-tested strengths, long known by the people that apply and ­promote this approach. First of all, it offers the benefit of giving access to so-called “exotic” assets. In other words, an investor can rely on the expertise of a professional to invest ­confidently in assets with limited visibility or liquidity (emerging markets, mid and small caps, etc). Also, the most talented managers are adept at ­generating outperformance in relation to their ­benchmark, or at least in offering a better-controlled risk/return ratio. A clever selection of mutual funds can offer a better Sharpe ratio than an investment in indices. Lastly, traditional management offers tremendous diversifying potential. Combining the different styles of each manager makes it possible to markedly reduce the volatility of an investment while preserving performance. Using different approaches – growth/value, small/big caps, top-down/bottom-up, etc) is a factor of ­decorrelation that contributes strong added value. For instance, one can reduce the volatility of an investment in European equities by around 20 per cent without ­affecting performance with an astute association of mutual funds invested in this asset class. Structured management Structured management offers three key assets distinct from those already mentioned. The first advantage is the ability to protect all, or part, of the ­capital invested. In the current market situation, this is ­particularly attractive. More generally, it makes it possible to change the ­distribution of earnings. Quite simply, this means it is possible to limit, or even ­eliminate completely, the ­probability of having ­disappointing performances. On the other hand, the probability of achieving a performance within a ­satisfactory range is increased. Structured asset management also makes it possible to link the investment’s performance on a limited number of parameters. For instance, a direct investment offers both exposure to the market and exposure to the ­manager’s outperformance capacity. With a structured product, exposure can focus on the manager’s ­outperformance capacity alone. Lastly, structured management can be tailored to ­an investor’s outlook. It can be engineered to factor in expectations of market trends, the desired investment period and the investor’s risk profile so as to offer ­customised exposure. Pooling adds value Combining a structured product with mutual funds brings all these advantages into play. As an ­illustration, let us take the example of a structured ­product focusing on outperformance. With the lack of a clear trend in equity markets, many investors face a growing risk aversion. They are looking for diversification products to strengthen their portfolio against any potential downturns. Therefore, there is a real demand for absolute return solutions with a preference for the short term and high protection levels. For an investor who believes in a manager’s stock-picking talent, but who has no directional outlook in equity markets in the medium term, investing directly in the fund would not be appropriate: although the ­manager can pick stocks likely to outperform over time, he will still be exposed to the general market trend. By bringing in structuring, we enable the investor to be exposed solely to the fund’s alpha. This engineering will generate a performance equal to a multiple of the fund’s outperformance relative to its benchmark over a pre-determined number of years, with a capital guarantee to protect the investor against any risk of underperformance. CPPI – one solution among others Structured asset management has long been associated with CPPI management, notably in the world of ­traditional asset management, where this structuring technique has been much used. It is a very apt approach for assets with relatively low volatility. But CPPI ­management has also suffered from the results ­generated on volatile assets due to the risk of ­monetarisation. There are far more efficient ways of being exposed to volatile assets; for example, via “zero coupon + call”-type structures. This is an appropriate approach for exposure to emerging markets, for example. Asset managers have an abundant fund offer in this asset class, providing simple access with genuine expertise, an ideal combination for investing in this type of market. Here, too, structured management can contribute determining added value. In addition to ensuring a long-term capital guarantee, structured management can also cushion shocks during the fund’s life by ensuring a floor for the quarterly or annual performance. Investors thus gain exposure to the tremendous potential of emerging markets with, the expertise of asset managers on the one hand, and the control of potential short-term downturns on the other, plus a strict capital guarantee at maturity. The right profiles A third example of a rewarding association of active and structured management is an approach that has been so successful with private investors it has now ­conquered institutional investors. Risk profiled funds have the advantage of offering an excellent risk/return ratio, and it comes as no surprise that they are often top-ranking performers. But when you ask the question, “Do you have a ­cautious, balanced or aggressive profile,” most investors feel like answering, “Cautious in a bear market, ­aggressive in a bull market!” The idea is to free investors from having to choose a risk profile to start with. The final performance is indexed on the profile that returns the best performance. Needless to say, the approach has met with great success with private banks and independent financial advisors. A world without boundaries Asset managers have plenty of ideas for opening up new types of thematic or management styles, ever more promising, and structurers have made innovation a ­priority to leverage or provide security to such ideas. Asset managers and structurers are bound to work in increasingly close co-operation for the greater benefit of investors. By pooling expertise, investors benefit from the best “mutual structures”. Romain d’Hébrail is head of investment and marketing for mutual fund derivatives at SG CIB.

Romain D’Hebrail