Harewood Solutions has the stability to overcome criticisms of structured products – the class of investment it offers. But the growth of exchange traded funds poses a threat, writes Tomas Hirst.
Structured product providers have endured some negative press in recent times and have come under criticism for a lack of transparency in the way they conduct their business. Harewood Solutions, part of the BNP Paribas group, is aiming quietly to change perceptions about structured product investing.
With the collapse of Lehman Brothers, the sale of Merrill Lynch to Bank of America and the Federal Reserve-facilitated sale of Bear Stearns to JP Morgan Chase, finding an investment bank that has proved resilient to the credit crisis has been a challenge. BNP Paribas, however, seems to have avoided the worst to date and Ryan Rogowski, head of Harewood Solutions, says that is one league table the bank is proud to be at the bottom of.
“If you look at some of the other products in the market after a bank has been downgraded or after the rating of your issuer changes, that will affect your NAV [net asset value],” he says. “So it’s critical that your issuer or provider remains stable so that you don’t get into a secondary market problem. Because you have the G7’s backing them you don’t see large NAV movements in our funds and we’ve actually been able to improve liquidity on our main range throughout the crisis.”
As Fund Strategy reported (September 15), the Investment Management Association (IMA) gave warning that the lack of any formalised disclosure practices for structured products made performance analysis difficult and undermined confidence. Rogowski, however, says he is not fazed by the criticism.
“Our primary market is primarily based on discretionary managers,” he says. “Most of them are already quite knowledgeable, sophisticated investors to begin with and I think a lot of that is to do with education. These are professional investors who are equally comfortable investing in equity products as they are alternative and structured products.”
Despite this, Rogowski says that there is a responsibility for structured product providers to ensure that the funds they offer are clear in both how they work and how they will cope with different market conditions.
“It is the investors’ responsibility to make sure they understand the product but on the flip-side we have a responsibility to make sure that the product is straightforward and transparent so that it’s not a complicated locked box,” he says. “In either case, regardless of the education you give, if the product is not clear in what it does, how it does it and how it is going to react to the market, people will probably not invest anyway.”
Certainly Harewood has found some industry figures who are sympathetic to its cause. Mick Gilligan, the director of fund research at Killik, says Harewood’s products in particular look attractive compared with most competitors.
“Of the structured products that are London-listed, theirs are probably among the highest quality I’ve seen,” says Gilligan. “The big differentiator is that the counterparty risk is collateralised as while BNP offers counterparty protection for the funds this is supported with government bonds.”
The posting of AAA-rated G7 government bonds as collateral was a major factor in stoking investor interest, despite the turmoil in the banking sector and the IMA’s warning. With increasing investor concern about the creditworthiness of counterparties on these types of products, it is surprising that Harewood remains almost unique in its use of this high-grade collateral.
One of the main reasons for this is the stability of BNP Paribas, which was reaffirmed AA+ by S&P in July and allowed it to keep the cost of buying in AAA-rated bonds low compared with its competitors.
“More and more people are asking about our credit rating, or at least paying closer attention to our credit strength, and use that as a more important part of deciding who to buy products from than before,” says Rogowski.
“We’ve launched across the credit crunch with Energy Base Metals 3 in May and our Tactical range [in July]. If you separate those two strands, whether it is the fund range which is collateralised with AAA G7 government bonds or the Tactical range, which is just BNP backing, both have been more than strong enough to attract capital.”
Tom Caddick, the head of multi-manager and fund selection at LV= Asset Management, says Harewood may even have benefited from market turbulence as investors increasingly looked at ways to control risk and preserve capital. “Structured products are likely to be of increasing interest in these kinds of environments,” says Caddick. “I’ve always seen [Harewood] as open to innovation and competitively priced.”
Harewood claims that its approach is reactive to demand in the marketplace: as soon as there is felt to be sufficient interest in a product, one can be created. In this way the company relies on feedback from clients to formulate investment ideas.
“Investors may be looking for something in particular and we customise our funds off that,” says Rogowski. “A great example is the Enhanced Property fund, which we launched in March. That was built on feedback from investors who wanted to get back into the property share market but were unsure about the timing.”
Property prices on both sides of the Atlantic were hit by the collapse of the subprime mortgage market and the consequent squeeze of liquidity. This led to record outflows from actively managed property funds in the retail arena, which in some cases led to freezes in redemptions so that underlying assets did not have to be sold to meet investors’ demands.
The Enhanced Property fund tracks the European Public Real Estate index and was designed to give investors exposure to property shares without the need to call the bottom of the market. The index has fallen by 22.5% since April 1, reaching its lowest point in July.
“If we look how the Enhanced Property fund has performed, property shares have fallen further since it launched,” Rogowski says. “However, the fund picked up and locked in an index low point in July at 1487, down from 1956 at launch, which means that so long as the shares recover, instead of receiving your performance from the starting point you get your performance from the low point.”
Gilligan, however, remains unconvinced that the structured product offers the best way to get exposure to property. “I think the property fund has struggled to make headway and we’d rather pick a particular fund we’ve got a better handle on,” he says. “The NAV is down 14% over six months, which is what you’d expect for that sector.”
Gilligan’s reservations on the property fund do not extend to Harewood’s entire range.
“We like the UK High Income fund,” he says. “If you have a client who wants exposure to high income you’re getting a pretty high yield of over 8.5%.”
Despite liquidity concerns in credit markets, Harewood has worked to ensure there is sufficient liquidity across its range, including in the fixed income space.
Rogowski says: “If you look specifically at the Harewood range, take the high income funds for example, throughout the credit crunch it paid its dividend of 7.5p without fail, but liquidity was much better in the equities space than in fixed income. It is important to focus on tradable markets so that we can effectively make our hedge in case there ever is a crisis.”
The company manages about $1.4 billion (£756m) and has seen inflows remain buoyant in 2008 while many firms have seen assets under management shrink in the face of investors’ nervousness.
Ben Yearsley, an investment manager at Hargreaves Lansdown, remains sceptical about the ability of structured products to break into the British marketplace in any significant way.”[Harewood] are trying to take structured products in a new direction, but whether they will be successful I don’t know,” he says. “I’m not convinced that structured products will take off in the British marketplace, especially as ETFs [exchange traded funds] seem more of a challenge for them than for mutual funds.”
The popularity of ETFs has grown exponentially over the past few years and, with a combination of high liquidity and low fees, they offer a challenge to closed-ended structured products. This is especially the case in sectors that have traditionally been difficult for individual investors to gain access to, such as agriculture funds.
Harewood launched an agriculture product, Agrinvest, in June 2007, at which time there were hardly any other products available in that sphere.
“When we launched Agrinvest, our commodities product, there may only have been very few if any ETFs at that time offering exposure to soft commodities,” Rogowski says. “In that example investors had barely anything to choose from on the ETF side and our product came out, which was simple and on top of that had capital protection. So there is opportunity in terms of access to underlyings.”
This, he says, was not the only reason for Agrinvest’s success. Commodities indices are based on the purchase of rolling futures contracts, which can affect performance when they have to be repurchased. The Harwood fund includes an enhancement designed specifically to combat this inefficiency and give investors smoother returns by minimising the cost of the futures contracts.
Although ETFs have enjoyed a surge in popularity, Yearsley’s concerns have not damaged investor interest in Harewood launches. The new Tactical range has attracted particular attention as it is a new area for the firm, designed to react quickly to market demand and launch small, flexible products with a minimum initial size of £1m compared with an average of £10m for a closed-ended product.
This would usually mean that the products aim to take in a maximum of £10m but the launch of the first product, the Tactical Accumulator 1 linked to the FTSE 100 index, showed investor interest to be stronger than anticipated.
“A huge factor behind why we launched the Tactical range in July was because investors felt that we were more likely to be around the whole lifespan of these products than our competitors,” says Rogowski.
“The idea behind it was being able to launch much smaller funds much more frequently, but we still took £30m in one of these products at first launch after having initially targeted £10m.”
With the Tactical range in place the group has turned its attention to it closed-end range. Harewood responded to growing investor appetite for absolute return strategies with the launch of the Platinium Absolute Return fund, which tracks the BNP Paribas Platinium index.
The fund will have a six-year life, offers investors 100% capital protection at maturity and, like the rest of the range, is backed by BNP Paribas and further collateralised with AAA-rated G7 government bonds.
It also offers about a 200% upside participation, locked in annually, to give investors double the return of the Platinium index, providing it is positive.
Rogowski says the reverse engineering approach based on feedback from clients singles Harewood out from other structured product providers. Gilligan, however, suggests that it is the liquidity in the funds that makes them attractive as investors are able to move out of them if they feel it is necessary.
“The advantage with these products is that you’re not tied in,” he says. “If you want to move out of them, BNP have made efforts to keep the liquidity to allow you to do this.”
If Gilligan is right, however, the prospect of ETFs eating into the market enjoyed by Harewood is a threat. On the other hand, the security of the capital protection in the funds, as well as the backing of an investment bank that has seemingly held up against a financial crisis in its own industry, may make the company’s brand more resilient that some of its competitors.
“Harewood sits within the equities and derivatives business of the corporate investment bank, which is a core part of the group as a whole,” Rogowski says. “So we can use the financial strength of BNP on the one hand but also use the huge platform that the bank provides to put together our products.”
HAREWOOD SOLUTIONS operates within the BNP Paribas group specialising in the design and management of fund investments. Assets under management total over $1.4 billion (£753m).