Supplements » ETFs 2010

ALTERNATIVES: Under scrutiny

DetectiveThere is a healthy amount of scepticism towards ETFs offering exposure to alternative asset classes, finds Angele Spiteri Paris.

Two of the main selling points of exchange-traded funds (ETFs) are that they are simple and transparent. But with products offering exposure to esoteric asset classes like private equity and hedge funds, these structures may well be drifting away from their central principles.

As with anything, there are two sides to every argument and this also holds true when it comes to talking about ETFs on alternative asset classes.

Some are vehemently opposed to the development while others, unsurprisingly those creating the products, say there are legitimate uses for these more obscure corners of the ETF world.

Matthieu Guignard, head of product development at Amundi ETF, hails from the former camp. He says: “I don’t consider the hedge fund ETFs to be ETFs. They’re more like a listed hedge fund because you don’t know what’s in them. Really, a hedge fund ETF goes against the whole premise of the product.”

In the most recent Funds Europe CEO panel, Robert Parker, senior advisor at Credit Suisse, highlighted the danger these complex ETFs can pose – pegging them as the next likely candidates for a blow-up in the financial world.

Not everyone is as negative. The ETF providers who have engineered the hedge fund and private equity ETFs, like db x-trackers and Invesco, are adamant that there is a place for these products in investors’ portfolios.

But Isabelle Bourcier, global head of Lyxor ETFs, says: “I’m not sure there is an appetite for ETFs on alternative asset classes, like hedge fund ETFs. The majority of assets remain in blue chips, leveraged products and emerging markets.”

However, movements in the market show that there is some interest, however slim. Manooj Mistry, head of db x-trackers ETFs UK, says: “We’ve seen good demand for our hedge fund ETF. We’ve raised $1.3bn [€0.9bn] over the 18 months since launch, with interest coming from a broad spectrum of investors, including European private banks and wealth managers.”

Dan Draper, head of ETFs at Credit Suisse, says: “Clearly, there’s demand for these alternative products among certain clients.”

Furthermore, although there are more hedge fund ETFs in the market now than there were a year ago, the products available are very different from one another.

Hedging your bets
Head of ETF licensing in Europe for Standard & Poors Indices, John Davies, says: “With any ETF the key thing is transparency and it’s hard to see hedge fund managers being keen to divulge their trading secrets. So the jury’s out on hedge fund ETFs. We’ll see how Source fares with its products.”

In September this year, Source, an exchange-traded product provider, launched two ETFs tracking the Merrill Lynch Factor Model strategy. This strategy, developed by Bank of America Merrill Lynch, aims to generate similar performance to funds of funds without investing directly in hedge funds. Instead, the model uses a portfolio of six liquid and well-known market indices to replicate the global performance of hedge funds.

Hedge fund manager Marshall Wace has also moved into the hedge fund ETF space. At the beginning of this year, the firm launched the MW Tops Global Alpha, a product it claims is the first equity market-neutral exchange-traded fund. In a release, the firm said: “It is the first ETF targeting an absolute return from a single investment strategy and the first ETF in Europe to be run by a dedicated alternative asset manager.”

The vehicle tracks the performance of the MW Tops Global Alpha Index, which itself will be based on a basket of Marshall Wace’s globally diversified Tops investment strategies. Marshall Wace claims the underlying holdings are extremely liquid and easy to price, which makes them especially well suited to the liquidity requirements of an ETF.

Davies, of S&P, says: “This [hedge fund managers offering ETFs] opens up the client base but you have to consider that none of the hedge fund products are new strategies. They’re all replicating existing strategies to offer access to a broader client base.”

But Mistry, at db x-trackers, disagrees: “The way we’ve set up our hedge fund ETF is quite unique and different to the replicator vehicles out there that try and mimic hedge fund performance. Our ETF is based on the performance of actual hedge fund managers on our managed account platform.”

This means, says Mistry, that the product has liquidity built in. He says: “The Deutsche Bank-managed account platform gives us visibility and access. We can see what the managers are doing. Because of this visibility, we’re happy to provide intra-day liquidity.” He notes that the underlying hedge funds usually have weekly liquidity, but that Deutsche Bank is used to guaranteeing liquidity.

But other experts in the market are sceptical about the level of liquidity that can be provided in these hedge fund ETFs.

Davies, of S&P, says: “The challenge with hedge fund ETFs is to make sure there is enough liquidity in the underlying to make the product sustainable.”

And generally providing, or guaranteeing, that liquidity is a challenge, mainly because of the nature of hedge funds as an asset class.

Vin Bhattacharjee, head of Emea intermediary business at State Street Global Advisors, says: “When an investment manager, like a hedge fund manager, has a specific skill their process has value in its own right. Therefore, the last thing that manager would want is for people to know exactly what it is they do. Which is why providing liquidity for a hedge fund ETF will be difficult.”

Draper, at Credit Suisse, says: “Liquidity is a valid concern, but this is where having the right process comes into the discussion.”

Credit Suisse launched a hedge fund exchange-traded note in February this year. The Credit Suisse Long/Short Liquid Index ETN is designed to correlate to the performance of the Credit Suisse Tremont Long/Short Equity Hedge Fund Index. The index to which the product is linked is designed to reflect the return of a basket of 18 liquid, investable market factors. These factors are then selected and weighted monthly in accordance with an algorithm that aims to track the performance of the Credit Suisse/Tremont Long/Short Equity Hedge Fund Index.

But although the exchange-traded hedge fund products in the market all claim to offer liquidity, Bhattacharjee, at SSGA, says: “People need to ask themselves why they need intra-day liquidity in a hedge fund product. I just think it’s a bit of a gimmick. They [the hedge fund ETPs] attract flows because of operational simplicity – buying such a product is easy.”

Private equity
Private equity ETFs seem to be considered less problematic than those on hedge funds, possibly because their suggested mode of use does not intend to take the place of direct private equity investment, but rather to supplement it.

Tim Mitchell, head of specialist funds at Invesco, says: “Listed private equity works well in an ETF. Through these vehicles, you’re not trying to offer direct exposure to private equity, which is inherently illiquid. That would be like trying to fit a square peg in a round hole.”

According to providers, the aim of private equity ETFs is to help sustain investors’ choice to make a particular allocation to the asset class.

Private equity, by its very nature, doesn’t allow for full, immediate exposure. Investors have to commit a certain amount of capital, which is then drawn down as and when investment opportunities come along.

Therefore, a listed private-equity ETF offers those investors an attractive alternative to cash while their committed capital is waiting for drawdown.

Draper, at Credit Suisse, says: “Rather than holding cash to a committed but undrawn down private equity portfolio allocation, it can make more sense for investors to invest in a private equity ETF.”

Mitchell agrees: “If you want to fully expose yourself to the asset class then buying a listed private equity ETF is appealing, until you can honour your commitments and make the direct investments.”

But the danger of opacity still exists. Davies, at S&P, says: “With ETFs tracking listed private equity, it’s a challenge for investors to understand exactly to what they’re getting exposure. With these types of vehicles they have to realise that they’re exposed to both the underlying private equity market and also the management of the private equity companies themselves.”

©2011 funds europe

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