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| Risk & Reward: Strategy |
Cash Withdrawals
John Ferry
03/01/2007
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A third option is to replicate the structure using
derivatives. “Instead of investing in a hedge fund and selling it forward to SG,
the client buys an option from SG, and then we go out and invest in the hedge
fund portfolio,” Debreu says. In this case, investors do not explicitly own the
hedge fund portfolio. Just as with any other over-the-counter derivative, the
contract the bank writes gives synthetic and leveraged exposure to the
underlying asset. Most investors will choose between the different methods based
on how much leverage they want, Debreu says. If they only need a small amount of
leverage, say 10 to 25 percent, then the simple loan is probably best. The
derivatives structures are better suited to those seeking higher amounts of
leverage.
Deals can get done
without having to
go through a thorough review of
the credit history of the individual. |
Ideal Assets
Debreu says a hedge fund portfolio is an ideal
asset to use as the basis on which to offer nonrecourse funding because a truly
diversified hedge fund portfolio typically has a low standard deviation (a
measure of risk). “If you look at a portfolio of hedge funds that is truly diversified in terms of strategy and in terms of number of managers, you get
down to an asset that has a standard deviation in the range of 4 to 6 percent.
So in terms of risk, a hedge fund portfolio is a great thing to lend against,”
he says.
Other assets, of course, can be used as loan collateral. Real
estate is popular, but with prices falling in the United States, banks today may
not be as willing to make those loans at attractive terms. Raising capital on
the back of concentrated equity positions is also common. A simple way to do
this is to use a derivatives-based structure known as a collar. “The collar
usually contains about 15 percent equity risk,” says Eric Leve, senior vice
president of international equities at investment company Bailard, based in
Foster City, Calif. “By selling a call option and buying a put option, out of
the money, you’re able to create a fairly narrow range in which you have equity
exposure, and, outside of that, you are capped. Institutions will then lend you
money against that, so you can monetize the collar,” he says.
 Boutique
outfits, such as New York–based New Millennium Financial, offer simple
nonrecourse loans against stock holdings. “We make loans at below market rates,”
says Austin Bleich, the company’s president. “They pay somewhere in the 4 to 5
percent fixed range basis, so if they feel that they can put that money to use
and earn more than 5 percent somewhere else, then of course it makes sense in
terms of diversification,” he says.
Such liquidity solutions are also popular
with executives or business owners who for various reasons need to retain
ownership of a large amount of single company stock. Although the underlying
stock is listed and is therefore liquid, an investor’s particular circumstances
(a delay in selling stock for tax reasons, for example) effectively makes it
illiquid. This type of equity-backed financing has been around for years and has
proven useful for many wealthy investors. Now, new products from sophisticated
firms allow them to extend the same principle and benefits to loans backed by
the alternative investments in their portfolios.
John Ferry is an Edinburgh, UK-based financial journalist and a senior
correspondent for Worth.
Additional Information
 Going Liquid: The Santa Fe Diversified Fund
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