May 17, 2015
In last weeks report, we showcased alternative investments as an attractive asset class. Alternative investments can be classified as investments in real estate, private equity and structured products. While relatively illiquid and more complex than traditional investments (fixed income and equities), alternative investments offer higher and more stable returns over the long-term as illustrated in our last weeks report.
Alternative investments are also referred to as private investments because you cannot access them from the public markets. For example, public / traditional investments are reported on daily in the press. And some like unit trusts are even required by regulation to report their pricing on a daily basis. On the other hand, alternative / private investments can only be accessed by invitation or by inquiry.
Having discussed alternative investments last week, we will now delve deeper into each type of alternative investment, starting with structured products:we will explain what they are, give an investable example, how the products are able to achieve higher returns and explain the key benefits.
Structured products are investment solutions, which are packaged by investment professionals, typically tailor made for the investor, to enable them access pockets of returns in the market that are not readily accessible through traditional investment avenues. They involve adding a layer of structuring to traditional products such as stocks, bonds and bank deposits. Structured products tend to be highly complex, but that complexity is compensated by significantly higher returns relative to traditional product alternatives.
Because of the two essential aspects of structured products, (i) the adding of a structure / feature to an existing product so that (ii) it fits a tailor made / specific need of an investor; structured products are largely privately manufactured, typically by alternative investment managers such as private equity firms, and privately placed to high net-worth investors and institutions through private placements.
This is not to say we cannot have structured products manufactured by traditional managers and / or publicly placed to the investing public. Examples of publicly placed structured products exist, but they are exceedingly rare. For example, Centums and ARMs equity linked notes are structured products. The issuers took a traditional product, a corporate bond, then added a structure, in this case an equity link, to develop an equity-linked note, which was issued to the public.
Examples of privately placed structured products include structured notes backed by high yielding assets such as real estate and commercial paper. The most common examplesof privately structured products in Kenya are real estate backed notes and the cash management solution(CMS) which could yield anywhere from 12% p.a. to as high as 16% p.a. depending on the underlying alternative asset and the duration of the investment.
Real estate backed structured notes is where a developer gets high net-worth individuals to finance a development for a specific return. For example, a developer looking for Kshs. 100 million development financing can either go to a bank to get development finance at say 16% per annum or the developer can go to 10 high net-worth individuals, each investing Kshs. 10 million to get the same Kshs. 100 million. The developer can offer the individuals a 13% return, better than the individuals would otherwise get in other products, and for the developer the 13% cost would be cheaper than they would otherwise get with a bank finance.
Another growing example of a structured product is CMS, which is a privately placed high-yield product that offers investors higher returns than they would get in other competing investment cash management options.
There are several ways that enable CMS to offer better returns to the investors:
To enhance the security of this product, the investment managers have to put in place a strong governance structure. Some of the key things that would be important to get right are:
Structured products are essential to private markets development and the economy for several reasons:
A concerted effort to support the development of the private markets sector is critical and urgent.
Next week we will focus on private real estate investment product opportunities.
Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.