Note : Les descriptions sont présentées dans la langue officielle dans laquelle elles ont été soumises.
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SYNTHETIC FUNDS HAVING STRUCTURED NOTES
Field of the Invention
[001] The present invention relates generally to investing, and more
particularly,
to a structured investment vehicle that provides superior returns while
reducing costs to
investors.
Background of the Invention
[002] Mutual funds were developed to give less affluent people the benefits of
diversification and access to the expertise of sophisticated asset managers.
Index funds
emerged with the promise of much reduced transactions costs, and improved tax
efficiency. The tax efficiency arises from the fact that index funds trade
infrequently,
giving individual investors the power to decide when to take gains and losses.
Notwithstanding substantial academic evidence that index fund returns exceed
the long-
term performance of the vast majority of managed funds, a very large
percentage of retail
equity assets are still invested in managed funds.
[003J Virtually all retail equity investments are based directly or indirectly
on
specific portfolios of stock. Consumers own stocks directly, and mutual funds
invariably
pass-through (after deduction of fees) investment returns of stocks bought for
the fund.
This pass-through structure is very capital efficient for asset managers.
Mutual fund
investors buy shares in specific assets that are protected by
trusteeslcustodians. So long
as the manager does not abuse his or her fiduciary obligations, the sole claim
of investors
is against pledged assets. Investors do not expect to be protected by the
balance sheet of
fund managers. Though the mutual fund industry has produced very good returns
for
fund managers, there is reason for concern that individual investors have
fared far less
well.
[004J One investment vehicle that has exploded in popularity during the early
2000's is the so-called "hedge fund." While the term is applied broadly, and
sometimes
indiscriminately, the term "hedge funds" generally refers to private
investment limited
pautnership vehicles run by managers who are compensated primarily based on
performance, rather than based on fixed fees or a fixed percentage of the
assets under
their management. Often, hedge fund managers have a personal stake in the
assets.
Typically, the hedge fund manager is a general partner in the partnership and,
the
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investors are limited partners. Typically, the strategy is set out in and
governed by the
partnership agreement created for the fund.
[005] Unlike conventional funds (like mutual funds) which are limited to a
single asset type (e.g., equities), hedge funds may broadly utilize various
asset types and
various strategies for managing those asset types. The asset types may include
equities,
bonds, currencies, precious metals, commodities, and so forth. The investment
instruments may include conventional stock purchase, options, futures, and the
like. The
strategies may include long positions, short positions, hedging, leverage,
derivatives,
arbitrage and the like, and combinations of the aforementioned.
[006] The point of hedges is that the assets and the strategies are selected
by the
fund manager according to any appropriate mix--a mix that will change as
economic
conditions change--to achieve good absolute returns. The concept of absolute
returns is
key in hedge fund theory. This is because the goal is not to outperform any
particular
market or index, but the goal is to provide a good absolute return
irrespective of any
particular market or index. This makes sense because the hedge fund may
reallocate its
assets, instruments, and strategies to avoid the downturns or limitations of
any particular
market or index.
[007] Generally, hedge funds will compensate their managers based on a portion
of profits, such as quarterly or annually. Fees of 15% or 30% of profits (so-
called
"performance fee") are not uncommon. A fee for fund management expenses (so-
called
"management fee") is typically charged to cover the manager's expenses,
typically about
1-3% of the funds invested. To the extent the fund manager has a personal
stake in the
funds, he is compensated in that regard as well for any growth. Therefore, the
other key
aspect of hedge funds that distinguishes them from conventional investment
vehicles is
the incentive-based compensation for the manager. This is in contrast to
conventional
brokerages which are compensated based on transaction fees unrelated to
performance.
Thus, hedge funds eliminate the motivation to "churn."
[008] The investment strategies charted by hedge fund managers vary greatly.
Although the name "hedge funds" suggests that they employ hedging strategies,
this is
not always the case. Those that employ hedging may use rislc mitigation
strategies by
selecting an element of the market (e.g., it could be a sector such as
telecommunications,
or it could be the entire market), and then designing their investment
strategy to invest in
that element of the market while minimizing risk from investment cycles. For
example, a
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hedge fund manager whose fund is based on utility stocks may broadly purchase
equities
in that sector, while also acquiring "put" options to sell should that sector
slump.
[009] The goal of many hedge funds is to have a zero "beta" relative to the
broader equities market. In other words, the hedge fund's performance is
preferably
unrelated to the market's performance, i.e., it is "market neutral." This can
be
accomplished in various fashions. One common strategy is so-called "pairs
trading,"
where the fund's manager seeks to buy and sell equities in pairs, the buy
being for a
relatively undervalued stock (relative to the rest of that sector) and the
sell being for a
relatively overvalued stock. Implementation of hedging using such strategies
not only
favors the investors in those hedge funds, but the overall market benefits by
becoming
more liquid as a result of the capture of the spread in the market.
[010] Another characteristic of hedge funds is that they are usually private
(largely unregulated by the SEC) and, therefore, cannot advertise. Members
(investors)
must be accredited and the number of investors generally cannot exceed ninety-
nine.
Generally, an accredited investor must have a net worth greater than $1
million and/or an
annual income exceeding $200,000. These limitations limit participation in
hedge funds
to a relatively small body of fairly affluent investors. As a result, the
typical investors in
hedge funds are accredited individuals, institutions, endowments, fund-of
funds, family
offices, and pensions.
[011] Another investment concept that has found popularity in recent years is
the
so-called "fund-of funds." A fund-of hedge funds may be a fund, such as a
mutual fund,
that invests in hedge funds. Or a fund-of funds may be a fund that holds
several classes of
assets, such as stocks and bonds. Generally, the fund-of funds interests are
issued as
shares that correlate to the underlying assets. Generally, a fund-of funds is
run by a
manager who can be viewed as managing the managers associated with the
underlying
funds.
[012] Fund-of funds are often implemented as a means to invest in multiple
hedge funds. Because of their high minimums and other restrictions, the
average investor
cannot invest in multiple hedge funds. A fund-of funds, however, can be set up
that
invests in various hedge funds without requiring a substantial investment for
each
investor. The manager of the fund-of funds, therefore, can diversify risk
among the
multiple managers of the underlying hedge funds. Generally, fund-of funds
managers
select the funds to diversify strategy, although not always. For example, a
strategy
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specific fund-of funds might be a fund of market neutral funds that only
invests in market
neutral funds.
[013] Much of the money entering the hedge fund market has been invested via
portfolios of many hedge funds selected by an experienced asset manager, i.e.,
the fund-
of funds instrument discussed above. These fund-of funds offer investors
experienced
management and diversification across many different hedge fund strategies.
Though the
fund-of funds impose an additional layer of expenses, market volatility can be
damped
significantly. It is believed that institutions own 80% of fund-of funds
assets.
[014] For a large institution wishing to enter the fund-of funds business,
there
are several options for entering the fund-of funds market. First, the fund-of
funds
capability could be built internally. For example, in the case of a large
bank, the
accounting and back office functionality is already available. Large banks
have good
track records in hedge fund performance, although this performance may not be
established with third parties. Therefore, while a bank might be able to
effectively market
its track record to "retail" (smaller investors), large institutional
investors are more likely
to choose managers with more experience. Another potential drawback to this
approach
is that developing a track record satisfactory to institutions can take years.
[015] Another option to enter the fund-of funds market would be to partner
with
a recognized fund manager. This approach may be effective for capturing retail
business.
In this case, a bank may earn the distribution premium, retain the assets, and
limit its
initial costs/risks. However, this partnering approach may not be effective
with
institutional investors because they can go directly to the fund-of funds
managers. In the
eyes of institutional investors, a bank may not be adding sufficient value in
this scenario
to justify the added costs.
[016] Yet another option would be to simply buy a fund-of funds business.
However, prices are currently very high. For example, recent prices for fund-
of funds
typically amount to 10% of assets. Only exceptional continued growth will
justify such
high prices.
[017] Some mutual funds advertise that they focus on tax efficiency. Usually,
this means that they try to reduce turnover, and invest for longer term. While
generally
benefiting long-term investors, this strategy does not avoid the tax pass-
through risk for
short-term investors. In addition, placing any constraint on trading means
that the
manager cannot optimize his cash returns.
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[018] At substantial cost, Fidelity recently announced it would enable its
mutual
fund shareholders greater ability to manage their taxes, by permitting them to
sell specific
shares previously purchased. While of potential value to a minority of
investors, of
greater moment to most investors is the unpredictable pass-through to
shareholders of
gains and losses recognized by mutual funds as fund managers trade securities.
[019] Other drawbacks may also be present.
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Summary of the Invention
[020] Accordingly, one aspect of the invention is to address one or more of
the
drawbacks set forth above.
[021] Another aspect of the present invention is to provide investment
opportunities that track conventional asset-based investments (e.g., hedge
funds, fund-of
funds, mutual funds, etc.) without requiring the synthetic funds
manager/obligor to
purchase the underlying asset.
[022] A further aspect of the invention is to provide investments, described
as
structured notes (which may include saps, derivatives, contracts, trusts, and
other types of
investments), with features and options that to date have typically only been
available to
institutional investors.
[023] An additional aspect of the invention is to provide consumers/brolcers
the
ability to: structure notes in real time, with tradable pricing/values; review
how the notes
would have performed during different historical periods; select features and
options that
optimize the investor's goals based on their risk/utility function and
outlook; execute and
memorialize the trade immediately without risk of rekeying errors or other
human
mistakes.
[024] By way of an exemplary embodiment of the invention, a process for
creating and issuing a synthetic fund with an unsecured structured note
comprises
receiving a request to purchase at least one structured note, where the
request comprises
an amount of the at least one structured note and at least one term of the at
least one
structured note, generating the at least one structured note based on the
request, receiving
payment for the at least one structured note, and issuing the at least one
structured note,
where the at least one structured note is an unsecured liability of the
obligor.
[025] By way of a further exemplary embodiment of the invention, a process for
creating and issuing a synthetic fund comprises receiving a request to
purchase at least
one structured note, where the request comprises an amount of the at least one
structured
note and at least one term of the at least one structured note, where the at
least one term of
the note includes a valuation of the at least one structured note based on at
least one
objective valuation measure and a time period for redeeming the at least one
structured
note, generating the at least one structured note based on the request,
receiving payment
for the at least one structured note, and issuing the at least one structured
note, where the
at least one structured note is an unsecured liability of the obligor.
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[026] According to another aspect of the invention, a process for creating and
issuing a synthetic fund comprises receiving a request to purchase at least
one structured
note, where the request comprises an amount of the at least one structured
note and at
least one term of the at least one structured note, where the at least one
term of the note
includes: a) a valuation of the at least one structured note based on at least
one
objective valuation measure, where the valuation is based on the at least one
objective
valuation measure without a predetermined amount of fees associated with the
objective
evaluation measure and a time period for redeeming the at least one structured
note,
where the valuation of the at least one structured note is based in part on
the time period
for redeeming the at least one structured note, generating the at least one
structured note
based on the request, receiving payment for the at least one structured note,
where the
payment for the structured note is based on the objective valuation measure at
the time of
the payment, and issuing the at least one structured note, where the at least
one structured
note is an unsecured liability of the obligor.
[027] Another exemplary aspect of the invention provides a synthetic fund for
purchase as a financial product comprising a structured note issued by an
obligor, where
the structured note is an unsecured liability of the obligor, and the
structure note
comprises at least one term, where the at least one term includes a valuation
based on at
least one objective valuation measure.
(028] By way of a further exemplary embodiment of the invention, a synthetic
fund for purchase as a financial product comprises a structured note issued by
an obligor,
where the structured note is an unsecured liability of the obligor, and the
structure note
comprises at least one term, where the at least one term includes a valuation
based on at
least one objective valuation measure and a time period for redeeming the at
least one
structured note, where payment for the structured note is based on the
objective valuation
measure at the time of the payment.
[029] According to an additional exemplary aspect of the present invention, A
synthetic fund for purchase as a financial product comprises a structured note
issued by
an obligor, where the structured note is an unsecured liability of the
obligor, and the
structure note comprises a plurality of terms comprising a valuation based on
at least one
objective valuation measure without a predetermined amount of fees associated
with the
objective evaluation measure and a time period for redeeming the at least one
structured
note, where the valuation of the at least one structured note is based in part
on the time
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period for redeeming the at least one structured note, and where payment for
the
structured note is based on the objective valuation measure at the time of the
payment.
[030] By way of a further example of the present invention, a system for
issuing
a structured note for a synthetic fund, the system comprises a request module
for
receiving a request to purchase the structured note, a generating module for
generating the
structured note, a purchase module for receiving payment to purchase the
structured note,
and an issuing module for issuing the structured note in response to the
request, where the structured note is an unsecured liability of the obligor.
[031] An additional embodiment of the invention provides a system for issuing
a
structured note for a synthetic fund. The system comprises a request module
for
receiving a request to purchase the structured note, where the request
comprises the terms
of the structured note and the amount of purchase, and where the terms of the
at least one
structured note further comprise the valuation of the structured note and a
time period for
redeeming the at least one structured note, a generating module for generating
the
structured note, where the generating module generates a unique identifier for
the
structured note and where the purchaser has an identifier, an purchase module
for
receiving payment to purchase the structured note, an issuing module for
issuing the
structured note in response to the request, where the structured note is an
unsecured
liability of the obligor and a storage module, where the storage module stores
and links
the unique identifier for the structured note and the purchaser identifier.
[032] According to a further exemplary embodiment of the invention, a system
for issuing a structured note for a synthetic fund comprises means for
receiving a request
to purchase the structured note, means for generating the structured note,
means for
receiving payment to purchase the structured note, and means for issuing the
structured
note in response to the request, where the structured note is an unsecured
liability of the
obligor.
[033] By way of a further example, a system for issuing a structured note for
a
synthetic fund comprises means for receiving a request to purchase the
structured note,
where the request comprises the terms of the structured note and the amount of
purchase,
and where the terms of the at least one structured note further comprise the
valuation of
the structured note and a time period for redeeming the at least one
structured note, means
for generating the structured note, where the generating module generates a
unique
identifier for the structured note and where the purchaser has an identifier,
means for
receiving payment to purchase the structured note, means for issuing the
structured note
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in response to the request, where the structured note is an unsecured
liability of the
obligor and means for storing and linking the unique identifier for the
structured note and
the purchaser identifier.
[034] A further exemplary embodiment provides a computer readable medium
for causing a process to issue a structured note for a synthetic fund
comprising code for
receiving a request to purchase the structured note, code for generating the
structured
note, code for receiving payment to purchase the structured note and code for
issuing the
structured note in response to the request, where the structured note is an
unsecured
liability of the obligor.
[035] According to a further example of the present invention, a computer
readable medium for causing a processor to issue a structured note for a
synthetic fund
comprises code for receiving a request to purchase the structured note, where
the request
comprises the terms of the structured note and the amount of purchase, and
where the
terms of the at least one structured note further comprise the valuation of
the structured
note and a time period for redeeming the at least one structured note, code
for generating
the structured note, where the generating module generates a unique identifier
for the
structured note and where the purchaser has an identifier, code for receiving
payment to
purchase the structured note, code for issuing the structured note in response
to the
request, where the structured note is an unsecured liability of the obligor,
and code for
storing and linking the unique identifier for the structured note and the
purchaser
identifier.
Brief Description of the Drawings
[036] Fig. 1 illustrates the relationship between an obligor, the market and
one or
more customers according to an embodiment of the invention.
[037] Fig. 2 illustrates a process for generating and issuing a structured
note
according to an embodiment of the invention.
[038] Fig. 3 illustrates a conventional funds-of funds where the underlying
assets
are hedge funds according to an embodiment of the invention.
[039] Fig. 4 illustrates an embodiment of the synthetic fund-of funds
according
to an embodiment of the invention.
[040] Fig. 5 illustrates a system for implementing a synthetic fund having one
or
more structured notes according to an embodiment of the invention.
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[041] Fig. 6 illustrates a graphic user interface for manipulating terms
according
to an embodiment of the invention.
[042] Fig. 7 illustrates a graphic user interface displaying the output of
manipulated terms according to an embodiment of the invention.
[043] Fig. 8 illustrates a graphic user interface displaying a report of the
status of
a structured note to the owner according to an embodiment of the invention.
Detailed Description of the Invention
[044] A system and process for synthetic funds is described. The system and
process make use of existing funds to provide investment opportunities in
structured
notes. One technical effect of the invention is to provide a system and
process for issuing
a structure note for a synthetic fund for investment purposes. Various aspects
and
components of this system and process are described below. While the present
invention
is described in terms of structured notes issued by an obligor, it is
recognized that swaps,
derivatives, contracts, trusts and other types may also be used, individually
or in
combination, as the basis for synthetic funds.
[045] Generally, a structured note, such as within a synthetic mutual fund
structure, may replace thinly capitalized fund managers with an issuer (also
referred to as
an "obligor"). According to an embodiment of the invention, an obligor may be
a credit-
worthy structure note issuer supported by substantial balance sheets. Instead
of buying
shares in a mutual fund, an investor may purchase one or more notes,
structured to
provide customized equity returnslexposure (also referred to as "structured
notes").
Terms of each structured note may be specified by the purchaser. According to
an
embodiment of the invention, structured notes may be unsecured liabilities of
the obligor,
e.g., there are no underlying assets upon which the structure note is based.
Thus, there
will be no limits on the use of structured note proceeds and management of
assets and
liabilities will be left entirely to the obligor's discretion. Structured note
payment
obligations may be related to the performance of an objective valuation, but
structured
note holders will depend on the good credit of the obligor for payment.
Various features
and aspect of structured notes will now be described in greater detail below.
According
to an embodiment of the invention, a value in selling structured note may
occur in that the
obligor receives the cash from the purchaser. This provides the purchaser with
the ability
to leverage a position, enter a short position, take certain risks, use a
derivative, provide a
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credit risk on an institution, or other actions. Use of a structured note may
avoid the use
of collateral and margin calls when a purchasers position becomes strongly
negative.
[046] Fig. 1 illustrates the relationship between an obligor, the market and
one or
more customers (hereinafter also referred to as "purchasers," "investors,"
"consumers,"
and "users")according to an embodiment of the invention. Obligor 100 is in
communication with one or more customers 110. In the relationship illustrated
in Fig. 1,
customers 110 are illustrated as customer A 111, customer B 112 through
customer N
113, where N is a whole number. It will be recognized that various numbers and
types of
customers may be involved.
[047] Market 120 comprises the entire market of objective valuation measures
and their underlying assets. By way of example, mutual funds 121, bond funds
122 and
hedge funds 123 are illustrated. However, it will be appreciated that market
120
represents the entire world of objective valuation measures and their
underlying assets,
and includes other assets.
[048] As illustrated in Fig. l, investors 110 are in direct contact with
obligor
100, as illustrated by lines 130. Investors 110 are further in indirect
contact with market
120, illustrated by dashed lines 140. According to an embodiment of the
invention,
investors 110 indirectly contact market 120 via receipt of information about
the market.
By way of example, values of mutual funds, bond funds, hedge funds, individual
stocks,
bonds, real estate and commodities and other assets in the market are often
published in
newspapers and on the Internet. Further, many funds advertise their valuations
in the
hopes of attracting new investors. Thus, investors 110 may indirectly contact
various
aspects of market 120 to determine what investments they desire.
[049] Investors 110 may directly contact obligor 100 to purchase a structured
note based on one or more objective valuation measures within market 120. For
example,
investor 111 directly contacts obligor 100 and requests to purchase a
structured note. In
this example, investor 111 may request that the structured note be value based
on a bond
fund 122 objective valuation measure. In response to this request, obligor 100
issues the
structured note. Further, obligor may then directly contact market 120 to
purchase the
underlying assets associated with objective valuation measure.
[050] According to an embodiment of the invention, an obligor may manage the
structured note liability very efficiently. On an aggregated basis, structured
notes may
represent a large and diversified portfolio of exposures. The vast bulk of the
exposure
may be captured by generic indices. By way of example, when stock and mutual
funds
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are used as an objective valuation measure, structured notes may represent a
large and
diversified portfolio of equity exposures. The exposure may be then captured
by generic
equity indices, e.g., the "Standard & Poor 500" ~ index, the "Wilshire 5000" ~
index, the
"Russell 2000" ~ index, etc. Further, the risk may be hedged in a number of
standard
ways, using stocks, futures or derivatives. As the dominant index risk will
change slowly
and turnover will be low with index funds, transaction costs for the obligor
will be
reduced.
[051] There may be some basis risk between the aggregated structured note
exposure and any combination of objective market measures. However, the
obligor
generally will have periodic snapshots (e.g., quarterly, semi-annually, etc.)
of the actual
holdings of every objective measure. By way of example only, a mutual fund may
make
semi-annual or quarterly reports publicly available of its holdings. The
obligor can
reduce its tracking error to an arbitrarily small number by adjusting: the
bulk index hedge;
sector index hedges; individual stocks or other underlyings (securities,
funds, etc.); the
cash position; the weighting of small capitalization share holdings as
compared to large
capitalization share holdings, etc.
[052] According to an embodiment of the invention, structured note holders may
shape the rislc and return of an investment (by introduction of option or
other derivative
characteristics) in a manner previously only available to institutional
investors. Thus,
structured note purchasers can, by selecting various parameters for the
structured note,
individualize the investment in the same manner as afforded institutional
investors.
[053] Managing option exposures is a scale business, which may be made easier
when the options are quite diverse (e.g., many different strike levels and
maturities).
Obligors may very efficiently offer structured note holders great flexibility
in customizing
their risk profiles. Risk management of the options embedded in structured
notes may be
simplified. Option traders are most concerned about heavily concentrated
option
exposures, which is not a concern regarding retail structured note investors.
By their
nature, structured note options are likely to be very diversified.
[054] Structured note obligations may be crystallized by objective valuation
measures, such as specific, publicly available market values. Careful
definition of those
critical market values may be required in order to avoid the risk of exposing
an obligor to
arbitrage by third parties, while enabling investors and an obligor to know
precisely the
terminal value of their synthetic funds investment.
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[055] The business of issuing structured notes is a business that can easily
be
institutionalized. Managing structured note liabilities is very
straightforward. Obligors
need not pay extravagant fund manager salaries or exorbitant premiums to buy
asset
management firms. Further, obligors may become the low cost producer in asset
management due to lower marlceting expense (piggy-back on mutual fund ads),
cheaper
issuance, lower administrative and accounting fees, smaller transaction costs,
etc. An
obligor's incremental regulatory overhead may also be less than the regulatory
overhead
for many mutual funds is substantial.
[056] To be economically feasible, mass customization of structured notes may
require substantial automation. Fortunately, the required technology is not
difficult to
implement. The obligor may make available an application for structuring,
pricing, and
comparing different structured note to various parties, such as to customers
online, and to
its brokers. Pricing parameters may be established centrally, taking account
for all
aspects of each structured note, including, but not limited to current market
conditions
(e.g., yield and volatility curves, and bid/asked spreads), historical
information (e.g.,
volatility for each fund, and covariance versus other funds), the risk in the
portfolio (e.g.,
does the structured note increase or decrease the risk in the portfolio) and
transaction
costs.
[057] Execution and documentation of structured notes may also be fully
electronic. Further, an obligor may also provide an application for showing
bids for
structured notes that are not currently redeemable.
[058] The obligor is likely to be able to accumulate assets relatively
inexpensively. Because obligor's cost structure may be lower, obligor will
have the
option to offer a higher return on structured notes than any underlying fund.
Various
other financial service providers, such as Merrill Lynch and Schwab
Investments, have
demonstrated the value of offering a broad range of investment vehicles.
However, in the
present invention, obligors can offer a broader range of fund products than
any fund
distributor. Obligors need not seek approval from fund managers in order to
reference
one of their managed funds in a structured note. Instead of merely earning a
distribution
premium, obligors will earn the full value provided to investors. Further,
mass
customization is desirable in many retail settings. At a tiny incremental
operating cost,
obligors can instantly offer investors unprecedented and unparalleled
customization
choice.
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[059] Shares in an equity mutual fund are never fully invested in stock.
Mutual
funds are usually around 90% equity and 10% cash. Without other resources to
accommodate unexpected redemptions, mutual funds must retain substantial cash
reserves. In a rising market, these cash reserves constitute a drag on fund
returns. Issuers
of structured notes will have many more options for dealing with redemptions.
Obligors
are very unlikely to retain specific cash reserves.
[060] Fig. 2 illustrates a process for generating and issuing a structured
note
according to an embodiment of the invention. At step 205, manipulation of the
terms of a
request is performed. At step 210, a request for one or more structured notes
is received.
At step 220, the request is processed, and one or more structured notes are
generated at
step 230. At step 240, a unique identifier for each structured note is
generated. The
identification of the requester and the unique identifier are stored at step
250. At step
260, payment is received for the purchase of the structured note. At step 270,
the terms of
the structured note and the purchase amount are stored. An issuance
confirmation is
transmitted at step 280. At step 285, the unique identifier, the purchaser
name, the terms
of the structured note and the purchase amount are linlced together. At step
290, the
structured note is issued. At step 295, post issuance actions occur. The steps
of the
process illustrated in Fig. 2 will now be described in greater detail below.
[061] At step 205, manipulation of the terms of a request is performed.
According to an embodiment of the invention, a consumer may be permitted to
manipulate one or more terms for a structured note prior to purchase. This
manipulation
of the terms allows a consumer to customize the structured note to meet the
consumers'
specific investment needs. Either alone or with the assistance of a broker or
other
financial advisor, a consumer may use a simulator to manipulate terms of a
structured
note to determine changes in prices based on various terms, such as by using
different
combinations of funds, different time frames, different risk exposures, etc.
According to
an embodiment of the invention, an optimization tool may be provided for use
by the
broker and/or the consumer. By way of example, a consumer may provide various
information about a desired structured note, such as the funds selected as the
basis, the
distribution of the funds, the investment goals of the consumer and the time
period for the
structured note. Other information and selections may also be used. The
optimization
tool then generates a proposed structured note optimized to meet the
objectives selected
by the consumer.
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[062] Another aspect of the present invention is a method to permit potential
buyers of structured note, investment advisors and brokers to iterate on
different note
structures to find the optimal combination of features for the individual
investor. Such a
method would involve a network of computer devices connected to a central
server
controlled by the obligor. Software on the access devices and the server would
permit
users of the system to search among many funds to find those with the
characteristics
desired by the potential investor. The system would then permit the user to
alter
characteristics of the returns of the fund, by changing terms of the note
including:
amount; teen; coupon; early redemption options; 'free exchange' options;
leveraging
exposures; adding or subtracting exposures to other funds, stocks, indices,
etc.; option
characteristics, e.g. principal protection, or incremental yield for giving up
a portion of
the potential upside; etc.
[063] The system would be linked to market parameters provided by the obligor,
which would permit users to see immediately the impact of each change on
various
aspects of the note. The obligor would be able to centrally provide the
necessary inputs
to price each note based on market parameters. For example, a user may
determine how
much incremental yield would be provided if the note holder forgoes returns in
excess of
10%. This would permit real-time pricing and sale of notes, without the need
to involve
traders or other risk managers.
[064] The system would also permit users to test the newly structured note to
review its performance over different historical time frames, in bull markets
and bear
markets. For example, a user may determine how would a newly structured 3-year
note
have performed, versus a simple purchase of the underlying fund, during the
period 1997-
2000. The system would permit users to compare total returns, including the
impact of
taxes, at the potential investor's tax rate. The system can also generate
tradable note
provisions, e.g., pricing and provisions that the obligor considers
acceptable.
[065] Further, the system would be structured to take inputs from users
regarding
an individual note and immediately prepare the necessary detailed legal
documentation
for the customized note. Once the investor chooses to execute the purchase of
a
structured note, the transaction will automatically be included in the
obligor's risk
systems, recorded in the obligor's books and records; and, all necessary
confirmation and
other legal requirements would be executed.
[066] According to an embodiment of the invention, a system may include a
database with information on funds used as the objective valuation measure in
the
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structured note, past performance of the funds, managements fees, advertising
fees, etc.
A processor accesses the database and processes selections of options for
terms of the
structured notes, determining historical returns and pricing.
[067] According to an embodiment of the invention, a graphical use interface
may be provided to enable a consumer, broker or financial advisor to
manipulate the
terms of the structured note before purchase a purchaser may call up,
historical data to
analyze how a particular structured note would have fared in a particular
economic
enviromnent. In addition, a purchaser may call up pricing information such as,
but not
limited to, the volatility curve and the yield curve, distributed across all
structuring
intervals. Fig. 6 illustrates a graphical user interface for manipulating
terms according to
an embodiment of the invention. In the example illustrated in Fig. 6, the
manipulation of
the terms of the structured note is provided in an Internet environment.
However, it is
understood that the manipulation may occur in other mediums and/or networks as
well.
Graphical user interface 600 includes a standard menu 605 that enables a user
to navigate
within the website.
[068] Graphical user interface 600 also includes portions to select
information
about that terms of the structured note. As illustrated in the example of Fig.
6, these
portions are in the form of pull down menus. However, it is recognized that
other
manners of enabling a user to select information about the terms of the
structured note
may also be used. At portion 610, a user may select the category of the one or
more
objective valuation measures to be used. Categories may include the specific
bond fund,
the specific mutual fund, the specific hedge fund, the specific commodity or
any other
objective valuation measure to be used in connection with the structured note.
Portion
615 may enable a user to select the sector of the one or more objective
valuation measures
to be used. Sectors may include, but is not limited to, the area of the market
(e.g.,
fmmcial services, technology, energy, telecommunications, transportation,
etc.) and the
goal of the fund chosen (e.g., large capitalization, small capitalization,
aggressive, growth
and income, etc.).
[069] Portion 620 enables a user to select a family of funds. Many fund
management companies, such a mutual funds, offer a number of different funds
to
consumers. For example, Fidelity Investments provides tens of fund options to
consumers. Thus, using portion 620, a consumer may select a fund family, and
then be
presented with options provided by that fund family in portion 625. This may
also be
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used with bond funds, hedge funds, commodity funds, real estate investment
trust funds,
and other types of objective measures.
[070] Portion 630 enables a consumer to determine the weighting of the
selected
objective valuation measures. According to an embodiment of the invention, a
consumer
may create a structured note based on more that one objective valuation
measure. For
example, a consumer could have 75% of the structured note based on a specific
mutual
fund and 25% on a specific bond fund. Other weightings and objective measure
could
also be used. If a consumer elects to explore the potential for a structured
note based on
more than one objective measure, an option may be presented to permit the user
to select
additional objective valuation measures. According to an embodiment of the
invention,
the weighting of the structured note may be greater than or less than 100 %,
depending
upon the selections of the purchaser. By using leverage, taking a short
position, taking a
long position, etc., a purchaser can alter the investment and the weighting.
Use of the
structured note obviates the need by obligors to make margin calls related to
leveraged or
short positions.
[071] Portion 635 enables a user to select the time period for the structured
note.
According to an embodiment of the invention, an obligor may offer a structured
note for a
particular time period. In exchange, the obligor may offer superior returns.
For example,
if a consumer purchases a structured note for a specific time period, e.g.,
eighteen month,
two years, five years, ete., the obligor may offer a better rate of return,
e.g., a return of
one percent above the selected objective valuation measurement.
[072] Portion 640 enables a user to select the valuation history time frame. A
user may select any time period, e.g., one year, five years, since the
inception of the fund,
etc., upon which to evaluate the potential for future expectations. For
example, if a user
wants to purchase a structured note for five years, it may be desirable to
base historical
returns on the performance of the underling objective valuation measure for
the past five
years.
[073] Portion 645 displays the historical return based on the selections made
by
the consumer while portion 650 displays the price of the structured note based
on the
selection.
[074] Fig. 7 illustrates a graphical user interface displaying the output of
manipulated terms according to an embodiment of the invention. As described
above,
graphical user interface 700 includes a standard menu 705 that enables a user
to navigate
within the website. In the example illustrated in Fig. 7, portion 710 displays
that the user
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selected "Mutual Funds." Portion 715 shows that the user has selected the
"Aggressive
Growth" sector.
[075] Portion 720 displays that the user selected "Fund Management Company
A," while portion 725 displays that the user selected "Fund AG." Portion 730
discloses
that the user desires a structured note based 100% on the selected fund.
Portion 735
displays that the user selected a two year structured note. Further, the user
selected a
valuation history of five years as displayed in portion 740.
[076] Portion 745 displays the historical return based on the selections made
by
the consumer while portion 750 displays the price of the structured note based
on the
selection. In the example illustrated in Fig. 7, the historical return is
calculated to be
8.75% per year while the price is the amount to be paid by the purchaser.
According to
an embodiment of the invention, purchasing a structured note may be similar to
purchasing a conventional bond, where the initial price does not change but
the return or
the structural changes based on attributes selected do change. Further,
investments in a
structured note may be "priced" based on a commitment by the purchaser. Thus,
a
purchaser may commit to a periodic investment (e.g., a monthly investment of
$100) to
purchase the structured note. The purchaser may then be given the structured
notes
immediately, with the pricing occurring based on the net present value of the
future
payments. Alternatively, individual structured notes may be purchased at the
time a
purchaser decides to make the investment.
[077] At step 210, a request for one or more structured notes is received. A
request may include one or more terms for the structured note. By way of
example, terms
may include the timing for redeeming the structured note, the amount or
amounts of
payments to be made, the basis for the valuation of the structured note and
the basis for
the performance of the structured note. Other terms for a structured note may
also be
used.
[078] According to an embodiment of the invention, the valuation of a
structured
note may be based on an objective valuation. Objective valuations may include,
but are
not limited to, a stock price, commodity price, an economic index, a mutual
fund, a stock
market index, a bond fund, a bond index, an inflation index, a hedge fund, an
interest rate,
etc. Standard valuations, such as a mutual fund, are comprised of a bundle of
attributes.
Because of its pass-through structure, all investors must be treated the same,
i.e. the
bundle is not optimal for any investor. A structured note permits
characteristics to be
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unbundled and customized to fit the exact needs of each investor on the basis
of the terms
of the structured note.
[079] The identity of the owner of the structured note may also be considered
part of the terms of the structured note. The request for the structure note
may come
directly from the owner, or may be made by a third party on behalf of the
owner. Further,
the owner may be an individual investor, a trust for an individual, an entity,
or anyone
else interested in an investment product.
[080] At step 220, the request is processed. Processing may include reviewing
the terms of the request and determining whether the terms are acceptable and
appropriate. By way of example, processing may involve the obligor ensuring
that the
objective valuation measure is appropriate and that the time period for
investment is
appropriate for the rate of return requested. Other types of processing may
also be used.
[081] At step 230, one or more structured notes are generated. At step 240, a
unique identifier for the structured note is generated. According to an
embodiment of the
invention, each structured note has a corresponding unique identification
(e.g., numeric,
alpha-numeric, etc.) that is unique to that structure note. Other manners of
identification
may also be used. Thus, for each structured note, an identification is
provided.
According to an embodiment of the invention, a structured note may be treated
in a
manner similar to a conventional mutual fund, where the unique identifier acts
as an
account number. Periodic updates, e.g., monthly, of the valuation of the
structured note
may be sent to the owner. Further, for marketing purposes, it may be desirable
to include
the actual return of the objective valuation measure and a contrast with the
return of the
structured note. Other information may also be included with a periodic
update.
[082] The identification of the owner of the structured note and the unique
identifier are stored at step 250. According to an embodiment of the
invention, the
identification of the owner and the unique identifier may be stored within a
database on a
data storage module. The identification of the owner and the unique identifier
may also
be associated within the database. Thus, the database may be accessed to
retrieve various
information about the structured note, including the owner, the purchaser, the
terms of the
structured note, and the valuation of the structured note.
[083] At step 260, payment is received for the purchase of the structured
note.
Payment may be received by any manner, such as by receipt of cash, check, or
wire
transfer. According to an embodiment of the invention, the amount of payment
for the
purchase is based on the objective valuation measure at the time of purchase.
By way of
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example only, if one of the terms of the structured note is that the objective
valuation
measure is based on a particular publicly traded bond mutual fund, then the
purchase is
based on the valuation of that particular bond mutual fund on the day of the
purchase of
the structured note.
[084] At step 270, the terms of the structured note and the purchase amount
are
stored. According to an embodiment of the invention, the terms of the
structured note
and the purchase amount may be stored within a database on a data storage
module. The
identification of the owner and the unique identifier may also be associated
within the
database. Thus, the database may be accessed to retrieve various information
about the
structured note, including the owner, the purchaser, the terms of the
structured note, and
the valuation of the structured note.
[085] At step 280, an issuance confirmation occurs. According to an
embodiment of the invention, issuance confirmation may include ensuring that a
broker
and/or purchaser receive a notification of the purchase of the investment. The
notification
may include a document having information about the structured note purchase,
the
purchase amount, the name of the purchase and the like. The document may be
transmitted via mail, email, fax, or other manner of transmission. Upon
receipt of the
issuance confirmation, the purchaser and/or the broker may be required to
approve the
purchase. According to an embodiment of the invention, the broker and/or
purchaser may
be given a certain period of time within which to reject the transaction
(e.g., twenty-four
hours, within two days of the purchase, etc.). If no rejection is received by
the obligor
within the specified time period, the transaction is considered approved. When
the
document is transmitted electronically, various electronic tools, such as
electronic
signatures, may be used to for transmission, rejection, and/or approval of the
transaction.
[086] At step 285, the unique identifier, the purchaser name, the terms of the
structured note and the purchase amount are linked together. Thus, the
database may be
accessed to retrieve various information about the structured note, including
the owner,
the purchaser, the terms of the structured note, and the valuation of the
structured note at
any time. Other associations may also be used to enable appropriate
information to be
retrieved as needed, such as all structured notes associated with one owner,
or all the
owners of a particular structured note. Other information may also be
obtained.
[087] At step 290, the structured note is issued. The issuance of the
structured
note may take any form, such as an account having periodic updates, a
certificate (e.g.,
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akin to a stock certificate) or other manner of issuing. At step 295, post
issuance actions
occur.
[088] Actions that occur after the issuance of the structured note may include
changing objective valuation measurements by the investor, altering the
weighting of
objective valuation measurements and communicating the status of the
structured note.
The status of the structured note may comprise the returns to date associated
with the
structured note, the current value of the structured note, the return of the
underlying
objective valuation measure, the difference between the value and/or return of
the
structured note and the underlying objective valuation measure and tax
benefits.
[089] Communication of the status of the structured note to the owner may be
performed in a variety of manners. For example, the status may be communicated
via a
period statement to the structured note holder via mail, e.g., monthly,
quarterly, yearly,
etc. The status may also be cormnunicated electronically, such as via email,
or via an
owner accessing an Internet site. Fig. 8 illustrates a graphical user
interface displaying a
report of the status of a structured note to the owner according to an
embodiment of the
invention. Graphical user interface 800 includes a standard menu 805 that
enables a user
to navigate within the website.
[090] Portion 810 represents the return of the structured note for the owner.
For
purposes of comparison, graphical user interface 800 further provides the
actual return of
the underlying objective valuation measurement in portion 815, the benefit to
the
structured note holder in portion 820, and the tax benefit to the structured
note holder in
portion 825. W the example illustrated in Fig. 8, portion 830 displays the
information
from the past quarter, portion 835 displays the information from the past
year, and portion
840 displays the information from the date of the purchase of the structured
note.
Additional information may also be displayed, such as forecasts for the
structured note
based on historic or estimated future returns over a given time period.
[091] Further, in the example illustrated in Fig. 8, a user may select the
appropriate tax bracket for that user. Thus, the tax benefit of portion 825
may be altered
based on the selection in portion 845. According to an embodiment of the
invention,
portion 845 may provide a drop down menu having a list from which a user can
select the
appropriate tax bracket. Other manners for selecting the tax burden, such as
selecting
either long term or short term capital gains, may also be used.
[092] In addition, comparisons between the return of the structured note and
the
return of the underlying objective valuation measurement and the tax benefits
may be
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provided in a number of manners. An owner may select to have the comparison
made in
percentage terms or absolute dollar terms.
[093] Fig. 3 illustrates a conventional funds-of funds where the underlying
assets
are hedge funds according to an embodiment of the invention. In Fig. 3, a
plurality of
investors 300 are permitted to invest in the fund-of hedge funds 350. Fund-of
funds 350
is managed by a fund manager who manages the plurality of hedge funds 375. A
first
level of fees are charged by the funds managers managing the individual funds
375. A
second level of fees are charged by the funds manager managing the fund-of
funds 350.
Thus, it can readily be appreciated that there are two levels of fees
(performance fees
and/or management fees) that are imposed in such a conventional fund-of funds
structure.
[094] An alternative, and improved, way to enter the fund-of funds market is
to
create a synthetic fund-of funds according to the present invention. According
to an
embodiment of the invention, an investment vehicle superior to any
institutional fund-of
funds offering on the market is to offer a structured note linked to a
specific fund of funds
but with a higher return that synthetically will provide a higher total return
as a
customized fund-of hedge-funds. Customers then may be able to combine existing
hedge
funds and/or fund-of funds to suit their particular needs. A customer may
customize a
fund of funds by adding or deleting underlying funds. By way of example, a
fund of fund
contains underlying funds 1 through 10. A customer may examine various
permutations
of structured notes, such as a structured note with only underlying funds 1-5
and 7-10, or
a structured note with underlying funds 2-10. Other permutations may also be
explored
before the customer purchases the structured note.
[095] Structured notes are hybrid securities, having features that may
include:
equity, commodities, straight debt instruments, etc., as well as derivative
instruments.
Interest payments on structured notes can be paid according to returns of
various indexes
or rates, in this case the performance of the underlying hedge funds in the
fund-of funds
composition selected by the investor. In addition to interest paid on the
structured note,
the redemption value and final maturity of the note can be affected by the
derivatives
embedded in the structured note (here again the underlying hedge funds).
[096] Fig. 4 illustrates an embodiment of the synthetic fund-of funds
according
to an embodiment of the invention. Rather than investing directly into a fund-
of funds
managed by a fund-of funds manager, investors 400 would select their own fund-
of funds
composition 475. For example, investor A 400 may select fund-of funds
composition
475 comprising hedge fund A, hedge fund C, and hedge fund X. Investor B 400
might
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select a fund-of funds composition 475 comprising hedge fund X, hedge fund Y,
and
hedge fund Z. Accordingly, the synthetic fund-of funds issuer would issue to
investor A
400 a structured note A 450 structured to provide the performance of investor
A's
selected fund-of funds 475 composition, whereas investor B 400 is issued a
structured
note B 450 structured to provide the performance of investor B's selected fund-
of funds
composition 475.
[097] While Fig. 4 illustrates the concept in terms of a fund-of hedge funds,
it
should be understood that the concept of issuing structured notes as synthetic
fund-of
funds could be applied based on underlying assets, long or short, leveraged or
not, of
nearly any form: hedge funds, mutual funds, individual equities, bonds,
commodities,
multiple fund-of funds (the structured note corresponding to a synthetic fund-
of multiple-
fund-of funds) and so forth. The issuer, or obligor, issues structured notes
that function
as a synthetic fund-of funds providing the investor the performance
corresponding to the
customized fund-of funds without requiring corresponding purchase by the
obligor of
those identical funds.
[098] By offering the performance of customized fund-of funds to individual
investors, the obligor may earn fees associated with fund-of funds while
enjoying a
reduced risk more commensurate with the broader market by virtue of the
diversity and
size of the overall asset collection maintained by the obligor. This may be
accomplished
because the obligor is able to manage the assets differently from the way in
which the
conventional fund-of funds manager manages its assets. According to one
embodiment
of the invention, the obligor offers the performance of a customized fund-of
funds
without actually acquiring a direct interest in those underlying funds.
Therefore, the
obligor does not pay the costs (e.g., performance fees and management fees)
associated
with the first layer of managers for the individual funds.
[099] According to an embodiment of the invention, obligor may short the
performance of the customized fund-of funds using structured notes, and
separately buy
and manage assets different from the underlying assets (e.g., the customized
fund-of
funds) sold. While it initially may appear counterintuitive, this intentional
asset/liability
mismatch may have several benefits. Accordingly, one benefit may be that the
obligor
would not need to buy an established fund-of funds company in order to offer a
few
seasoned performers. Instead, the obligor could offer its customers assets, in
the form of
the structured notes, matching exactly the performance of any fund of funds
for which
obligor can obtain data. According to an embodiment of the invention, this is
likely to be
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a richer choice than any other single institution can offer since any single
institution is
unlikely to be able to invest in every fund-of funds in existence.
[0100] Another benefit may be that obligor may offer its customers the ability
to
customize their exposures in ways not available elsewhere. Obligor's customers
could be
permitted to buy the performance of a well regarded fund-of funds, and then
modify the
composition by adding and subtracting individual fund exposures, hedge funds,
indices,
stocks, ete. By way of example, an investor might select a structured note
based on a
particular fund of funds, and include a short or long position in specific
hedge funds. W
this way, investors can under- or over- weight individual funds or hedge fund
strategies.
Similarly, with mutual funds, stock positions can be over or under weighted.
Because
such customization does not require any actual transactions in the underlying
assets, such
changes conceivably could be made dynamically through time.
[0101] A further benefit may provide that investors may have the ability not
only
to customize the content of the synthetic fund, but additionally (or instead)
the ability to
customize the strategy employed. For example, the investor may favor the
prospects of a
particular fund-of funds XYZ, but may be less enthusiastic for the prospects
of
employing a pairs trading strategy for the foreseeable future. The obligor may
offer the
performance of the fund-of fiends XYZ as customized to remove pairs trading.
[0102] Further, instead of simply earning a small distribution spread as a
reseller
of funds, obligor may capture the full amount of various layers of fees (e.g.,
the hedge
fund manager's fees, the fund-of fund manager's fees, etc.). Because the
obligor, the
issuer of the structured notes providing investors the performance of
customized fund-of
funds, is not actually acquiring interests in the underlying funds, management
fees may
be avoided. This may allow the obligor to receive the various layers of fees
or to discount
fees for investors.
[0103] According to an embodiment of the invention, options otherwise not
feasible or not permitted in conventional investments may be supported. By way
of
example, an investor can structure its structured note to place caps on
losses/gains. In this
manner, note holders would have the ability to shape their risk profile in the
way that best
suits them. For example, an investor willing to accept a maximum return of 10%
over the
term of the structured note, would be entitled to an incremental return. An
investor with a
specific liquidity requirement (e.g. college tuition), might choose principal
protection
with the specific term and amount he needs. While the result of principal
protection will
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be to reduce the return of the structured note, it will substantially increase
the investor's
certainty.
[0104] While negotiating the structured note, investors may require an early
redemption option, or the right periodically to reallocate their investment
exposures.
Without regard to fund restrictions, obligors can accommodate such investor
desires.
Fund management groups frequently allow periodic 'free exchanges,' shifting by
investors their exposures, from one fund to another, within a single fund
family at no cost,
e.g. investing the proceeds of an equity growth fund into an equity income
fund. At small
risldcost, obligors will be able to offer 'free exchanges' across multiple
fund management
groups.
[0105] Implementation of the synthetic fund using the present invention may be
feasible for a larger financial institution with large balance sheets that may
choose to own
assets that are different from their liabilities, in this case the structured
fund-of funds
notes it sells. Such larger institutions need not simply match assets and
liabilities, as may
be required by smaller entities such as fund-of funds groups or mutual fund
management
companies. Therefore, the structured notes need not match or correspond to the
assets.
[0106] The issue of the risk to the issuer of having mismatched assets and
liabilities may be dealt with across the aggregate valuation of the structured
notes issued
by the obligor. With enough investors, and very lightweight controls, the
overall returns
of the structured notes should closely track the general market for fund-of
funds. The
S&P is in the process of establishing a hedge fund index, using 40 funds as a
proxy for
the 6,000 funds currently in the market. The New York Times wrote "Standard &
Poor's
says its statistical research shows that 30 to 40 funds reliably reporting
their performance
data can accurately represent a much larger universe." Therefore, whether the
right
number is 40 or 200, the obligor may assure its structured note exposure
represents the
general fund-of funds market, without undue concentration to particular names
that might
substantially exceed average returns.
[0107] According to an embodiment of the invention, the obligor may choose to
invest structured note proceeds (e.g., the moneys paid by the investors to
acquire
structured notes corresponding to their customized fund-of funds) in funds
that mimic or
simulate the exposures of the structured notes. This strategy would be very
successful if
obligor asset managers continued to beat the market. If the obligor managers
just
matched market performance, obligor may still earn the full fees. In addition,
if the
obligor is a sufficiently large company, such as a large financial
institution, the obligor
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may use its wholesale buying power to gain access to the most attractive funds
and to
negotiate reduced fees.
[0108] On the issue of risk, different fund strategies perform differently
over time.
However, within categories of strategies (e.g., pairs trading, convertibles,
risk arbitrage,
etc.), performance among fund managers and funds is generally pretty similar.
A
substantial amount of basis risk may be eliminated if the obligor invests in
fund strategies
on parity with the structured notes chosen by note holders. Therefore,
although the
liabilities and assets will be mismatched, strictly speaking the respective
performances
should be about the same, thus minimizing risk to the obligor.
[0109] There may be another attractive aspect for the obligor in selling fund-
of
funds structured notes (e.g., synthetic hedge funds). Typically, hedge funds
investors can
"cash out" (liquidate their positions) within 90 days, while structured notes
usually have
multi-year terms. Some hedge funds will make fee concessions if funds are
committed
for a fixed tern, e.g., 3-5 years. Therefore, the longer terms of the
structured notes may
allow the obligor to reduce the costs of acquiring corresponding assets in
hedge funds.
[0110] Of course, dependable and accurate information is important to the
success
of the synthetic fund instrument. To offer synthetic funds may require
detailed
performance information. In some instances, such information is not always
readily
available. As discussed previously, hedge funds are usually structured as
limited
partnerships and generally are not required to publicly report their
performance.
Notwithstanding, there are ways by which the obligor can gain access to
sufficiently
accurate performance information in order to successfully offer the synthetic
fund-of
funds.
[0111] Offering of a synthetic fund may provide good returns to an obligor.
Selling what the market wants to buy is the lowest cost means of distribution.
Fund-of
funds and actively managed funds charge relatively high fees. These fees are
on top of
fees paid to hedge fund managers. Therefore, offering structured notes should
be
lucrative.
[0112] Structured notes may also provide a wonderful opportunity to provide
customers access to a rich array of premium products, while at the same time
allowing
obligors to retain much or all of the management fees. With only one level of
distribution, obligors may offer the performance of prominent fund-of funds at
discounted fees.
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[0113] As general structured notes are already well understood and accepted by
investors, such structured notes of the present invention should not be
resisted by the
investment community. In addition to being well understood, structured notes
may
provide some benefits not available in the more ordinary fund-of funds
investments.
Particularly in Europe and Asia, there is a large appetite for principal
protected notes that
offer most of the investment characteristics of alternative investments.
[0114] Sometimes investor preference for such structured notes is related to
regulatory arbitrage. Several portfolios of private equity participations have
been sold
using principal protected notes. Buyers limited by the size of their
alternative investment
baskets were able to obtain an upside similar to private equity. These notes
carried a term
of 15-years and a AAA guarantee of the principal. Some regulated investors
simply
booked the notes as if they were AAA debt, though without a coupon, the
guarantee is
worth less than half the original investment.
[0115] Also, structured notes may permit additional flexibility in offering
investors customized risk/rewards structures. Since there is no commodity
market for
such offerings, and no current price competition, this too could be an
attractive business.
[0116] In principal, an obligor could offer exposures to every public mutual
fund,
as well as every listed security, index, commodity price, etc. Investors could
combine a
number of different equity exposures in a single structured note, or have a
series of
structured notes. Investors may choose to leverage their equity exposure up to
a
maximum established by the obligor. In a single structured note, an investor
could
choose to take long exposures to some funds, and short the performance of
other funds.
[0117] Some mutual funds have been launched based on a strategy of capital
preservation. Qptions traders recognize this strategy as 'delta hedging,' an
attempt to
simulate a put option by constantly adjusting the cash/equity mix. In volatile
markets,
this strategy can be extremely costly. The strategy's efficacy is uncertain,
and depends on
market liquidity during times when markets are inherently illiquid. During the
19$7 stock
market collapse, 'delta hedging' was blamed for a substantial portion of the
sell side
pressure.
[0118] Capital preservation is generally not considered a great strategy for
mutual
funds. Mutual fund managers typically do not buy option protection, and are
not well
positioned to manage short-options positions. There are substantial scale
economies to
managing option books. Delta hedging requires lots of trading, and transaction
costs
(bid/asked spreads) for most mutual funds are high. In addition, each investor
has a
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different view of the term of investment and amount of capital he or she would
like to
preserve. Inherently, the fund manager cannot optimize for each investor, nor
can he
make clear to investors the cost or efficacy of the protection on offer. By
contrast, an
obligor can offer principal protection customized to the needs of each
structured note
holder, reliant only on the credit of the obligor.
[0119] Puts and calls with the same strike and term are priced using the same
volatility assumptions. However, in some cases people's behavior, choices and
judgments may be impossible to reconcile with a rational model. For example,
one
systemic human bias is that that losses loom larger than gains. Studies of
equity risk
premium have concluded that losses hurt roughly 2.25 times more than gains
satisfy.
Under such circumstances, one would expect retail investors would value the
ability
efficiently to reduce their downside exposures.
[0120] Institutional investors frequently take advantage of risk/return
shaping that
so far has been unavailable to individuals. During the bull market, many
institutions
bought 'costless collars,' that protected a portion of their gains, while
funding the cost
(long a put option) by forgoing a portion of potential additional upside
(short a call
option). Such strategies for individual stocks would be quite costly for
individuals, and
currently completely unavailable for mutual funds.
[0121] Tax consequences of gains recognized by mutual funds are passed through
to shareholders. Shareholders in mutual funds generally have little notion of
their
potential tax liability connected with unrealized fund gains. In addition, the
timing of tax
liabilities is completely unpredictable. Fund realization of taxable gains can
inflict
substantial, uneven and inequitable penalties on different shareholders. An
investor who
held a fund for a short time during which the manager chose to realize large
gains may
still be liable for the tax consequences.
[0122] Structured notes will be capital assets. Unlike mutual funds, there
will be
no pass-through of tax liabilities. Note holders will not face unpredictable
tax
consequences. However, structured note holders will incur ordinary income for
structured note coupons (e.g., direct or OID), and coupon income may exceed
dividend
income from the underlying stock positions.
[0123] Mutual funds offer every investor the same liquidity. Issuers of
structured
notes can offer different liquidity provisions to each investor, at prices
that reflect the
economic value of the liquidity. Investors could select different
redemptions/call/term
options, e.g., a fixed term note, redeemable after one year, once a week, at
various
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redemption discounts, callable at a premium, extension options, either by the
obligor or
the investor, etc. Obligors might be happy to offer investors with a three-
year investment
horizon higher returns than offered to short-term investors.
[0124] Structured note holders may also individually choose the manner by
which
they want to take their structured note returns. Some will choose to maximize
potential
long-term capital gains. Others may seelc periodic fixed, or variable (e.g.,
linked to short-
term interest rates, or capital gains) payments. The structure of structured
note cash flow
can be extremely flexible.
[0125] One example of a manner in which a structured note according to the
present invention may be implemented is set forth below in the example of
Sample Note
#1. The structured note links to the performance of the Fidelity Magellan
Fund, with a
principal amount of $20,000. The structured note closes on December 15, 2002,
and the
final note payment occurs on the earliest o~ (i) three years from the date of
closing; (ii)
five days following early redemption by the investor; or (iii) five days after
the selected
mutual fund ceases to be a mutual fund. The structured note pays two percent
semi-
annually, paid on a 30/360 basis. On the final structured note payment date,
the obligor
will pay the amount that will provide the investor a yield equal to the
greater of: (i) 50
basis points more than the yield of the selected mutual fund; or (ii) 105% of
the yield of
the selected mutual fund, which in this example is the Fidelity Magellan Fund
(currently
closed to new investors). Early Redemption is permitted on the first date
following
receipt by the obligor of effective written notice by the investor, after the
first anniversary
of the closing. The semi-annual internal-rate-of return, using standard
methods, is
calculated: (i) for the selected mutual fund-taking account for all cash flows
the
investor would have received had he or she made an investment of the principal
amount
in the selected mutual fund during the term of the structured note, and
received the final
NAV on the final payment date; (ii) for the structured note-taking account for
all
coupons received during the term of the structured note, and the amount paid
on the final
stmctured note payment date. The final NAV is the arithmetic average of the
last four
reported NAV calculations, prior to the final structured note payment date.
[0126] Another example of a manner in which a structured note according to the
present invention may be implemented is set forth below in the example of
Sample Note
#2. The structured note links to the Fidelity Magellan Fund, with a principal
amount of
$20,000 and a closing date of December 15, 2002. The final structured note
payment date
is December 15, 2005. On the final note payment date, the obligor will pay the
amount
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that will provide the investor with a yield equal to the greater of: (i) 20
basis points less
than the yield of the selected mutual fund; or (ii) the protected principal
amount, where
the protected principal amount is $18,000. The mutual fund is any actively
managed,
publicly traded, open-ended mutual fund, which in this case is the Fidelity
Magellan Fund
(currently closed to new investors). The yield is the semi-annual internal-
rate-of return
calculated: (i) for the selected mutual fund-taking account for all cash flows
the
investor would have received had lie made an investment of the principal
amount in the
selected mutual fund during the term of the structured note, and received the
final NAV
on the final payment date; (ii) for the structured note-taking account for all
coupons
received during the term of the structured note, and the amount paid on the
final
structured note payment date. The final NAV is the arithmetic average of the
last four
reported NAV calculations, prior to the final structured note payment date.
[0127] One example of a manner in which a structured note according to the
present invention may be implemented is set forth below in the example of
Sample Note
#3. The structured note links to the Fidelity Magellan Fund. The principal
amount is
$20,000. The closing date is December 15, 2002, and the final note payment
date is
December 15, 2005. On the final structured note payment date, the obligor will
pay the
amount that will provide investor a yield equal to: (i) 40 basis points more
than the yield
of the selected mutual fund; but, (ii) not less than the protected principal
amount, where
the protected principal amount is $18,000; and (iii) not more than $23,000.
The semi-
annual internal-rate-of return is calculated: (i) for the selected mutual fund-
taking
account for all cash flows the investor would have received had he made an
investment of
the principal amount in the selected mutual fund during the term of the
structured note,
and received the final NAV on the final payment date; (ii) for the structured
note-taking
account for all coupons received during the term of the structured note, and
the amount
paid on the final structured note payment date. The final NAV is the
arithmetic average
of the last four reported NAV calculations, prior to the final structured note
payment date.
[0128] A further example of a mamier in which a structured note according to
the
present invention may be implemented is set forth below in the example of
Sample Note
#4. The structured note links to a selected mutual fund portfolio. In this
example, that
comprises a long position of $30,000 on the Fidelity Magellan Fund and a short
position
of $20,000 on the Fidelity Emerging Markets Fund. The principal amount is for
$20,000,
with a closing date of December 15, 2002, and a final structured note payment
date of the
earliest of: (i) three years from the date of closing; (ii) five days
following early
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redemption by the investor; or (iii) five days after any of the mutual funds
in selected
mutual fund portfolio ceases to be a mutual fund. On the final structured note
payment
date, the obligor will pay the sum of: (i) the principal amount; (ii) 1 %
interest on the
principal amount; plus, (iii) the final NAV of the selected mutual fund
portfolio, less the
NAV of the selected mutual fund portfolio on the closing date. Early
redemption is
thefirst date following receipt by the obligor of effective written notice by
the investor,
after the first anniversary of the closing. Final NAV is the arithmetic
average of the last
four reported NAV calculations, prior to the final note payment date.
[0129] Fig. 5 illustrates a system 500 according to an embodiment of the
present
invention. The system 500 comprises a plurality of computer devices 505 (or
"computers") used by a plurality of users to connect to a network 502 through
a plurality
of connection providers (CPs) 510. The network 502 may be any network that
permits
multiple computers to connect and interact. According to an embodiment of the
invention, the network 502 may be comprised of a dedicated line to connect the
plurality
of the users, such as the Internet, an intranet, a local area network (LAN), a
wide area
network (WAN), a wireless network, or other type of network. Each of the CPs
510 may
be a provider that connects the users to the network 502. For example, the CP
510 may
be an Internet service provider (ISP), a dial-up access means, such as a
modem, or other
manner of connecting to the network 502. In actual practice, there may be
significantly
more users connected to the system 500 than shown in Fig. 5. This would mean
that there
would be additional users who are connected through the same CPs 510 shown or
through
another CP 510. Nevertheless, for purposes of illustration, the discussion
will presume
four computer devices SOSa-SOSd are connected to the network 502 through two
CPs 510.
[0130] According to an embodiment of the invention, the computer devices SOSa-
SOSd may each make use of any device (e.g., a computer, a wireless telephone,
a personal
digital assistant, etc.) capable of accessing the network 502 through the CP
510.
Alternatively, some or all of the computer devices SOSa-SOSd may access the
network 502
through a direct connection, such as a Tl line, or similar connection. Fig. 5
shows the
three computer devices SOSa-SOSd, each having a connection to the network 502
through
the CP SlOa and the CP SlOb. The computer devices SOSa-SOSd may each malce use
of a
personal computer such as a computer located in a user's home, or may use
other devices
which allow the user to access and interact with others on the network 502. A
central
controller module 512 may also have a connection to the network 502 as
described above.
The central controller module 512 may communicate with one or more modules,
such as
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one or more data storage modules 514, one or more processor modules 516, or
other
modules.
[0131] Each of the computer devices 505a-505d used may contain a processor
module 504, a display module 508, and a user interface module 506. Each of the
computer devices 505a-5054 may have at least one user interface module 506 for
interacting and controlling the computer. The user interface module 506 may be
comprised of one or more of a keyboard, a joystick, a touchpad, a mouse, a
scanner or
any similar device or combination of devices. Each of the computers 505a-SOSd
may also
include a display module 508, such as a CRT display or other device. According
to an
embodiment of the invention, a developer, a user of a production system,
and/or a change
management module may use a computer device 505.
[0132] The central controller module 512 may maintain a connection to the
network 502 such as through a transmitter module 520 and a receiver module
518. The
transmitter module 520 and the receiver module 518 may be comprised of
conventional
devices that enable the central controller module 512 to interact with the
network 502.
According to an embodiment of the invention, the transmitter module 520 and
the
receiver module 518 may be integral with the central controller module 512.
According
to another embodiment of the invention, the transmitter module 520 and the
receiver
module 518 may be portions of one connection device. The connection to the
network
502 by the central controller module 512 and the computer devices 505 may be a
high
speed, large bandwidth connection, such as through a T1 or a T3 line, a cable
connection,
a telephone line connection, a DSL connection, or another similar type of
connection.
The central controller module 512 functions to permit the computer devices
505a-505c to
interact with each other in connection with various applications, messaging
services and
other services which may be provided through the system 500.
[0133] The central controller module 512 preferably comprises either a single
server computer or a plurality of server computers configured to appear to the
computer
devices 505a-505d as a single resource. The central controller module 512
communicates
with a number of modules. Each module will now be described in greater detail.
[0134] A processor module 516 may be responsible for carrying out processing
within the system 500. According to an embodiment of the invention, the
processor
module 518 may handle high-level processing, and may comprise a math co-
processor or
other processing devices.
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[0135] Data may be stored in a data storage module 514. The data storage
module 514 stores a plurality of digital files. According to an embodiment of
the
invention, a plurality of data storage modules 514 may be used and located on
one or
more data storage devices, where the data storage devices are combined or
separate from
the controller module 512. One or more data storage modules 514 may also be
used to
archive information.
[0136] Issue module 522 may issue structured notes and/or synthetic funds.
Issuing may include forwarding a certificate and/or statement related to the
structured
note to the owner. A statement may be provided on a periodic basis, e.g.,
monthly,
quarterly, etc. Statements may be provided electronically, such as via email
or by
providing a secure Internet site for an owner of the structured note to access
information.
Further, as statements may be provided in hard copy form, e.g., a paper print-
out of the
structured note performance, issue module 522 may include, or have access to,
equipment
necessary to print out a statement.
[0137] While the system 500 of Fig. 5 discloses the requester device 505
connected to the network 502, it should be understood that a personal digital
assistant
("PDA"), a mobile telephone, a television, or another device that permits
access to the
network 502 may be used to arrive at the system of the present invention. It
is understood
that, while system 500 is represented in Fig. 5 as a network based system,
other systems
may also be used, with applicable modules resident therein. Other systems may
also be
used.
[013] According to an embodiment of the invention, the systems and processes
described in this invention may be implemented on any general purpose
computational
device, either as a standalone application or applications, or even across
several general
purpose computational devices connected over a network and as a group
operating in a
client-server mode. According to another embodiment of the invention, a
computer-
usable and writeable medium having a plurality of computer readable program
code
stored therein may be provided for practicing the process of the present
invention. The
process and system of the present invention may be implemented within a
variety of
operating systems, such as a Windows~ operating system, various versions of a
Unix-
based operating system (e.g., a Hewlett Packard, a Red Hat, or a Linux version
of a Unix-
based operating system), or various versions of an AS1400-based operating
system. For
example, the computer-usable and writeable medium may be comprised of a CD
ROM, a
floppy disk, a hard disk, or any other computer-usable medium. One or more of
the
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components of the system or systems embodying the present invention may
comprise
computer readable program code in the form of functional instructions stored
in the
computer-usable medium such that when the computer-usable medium is installed
on the
system or systems, those components cause the system to perform the functions
described. The computer readable program code for the present invention may
also be
bundled with other computer readable program software. Also, only some of the
components may be provided in computer-readable code.
[0139] Additionally, various entities and combinations of entities may employ
a
computer to implement the components performing the above-described functions.
According to an embodiment of the invention, the computer may be a standard
computer
comprising an input device, an output device, a processor device, and a data
storage
device. According to other embodiments of the invention, various components
may be
computers in different departments within the same corporation or entity.
Other
computer configurations may also be used. According to another embodiment of
the
invention, various components may be separate entities such as corporations or
limited
liability companies. Other embodiments, in compliance with applicable laws and
regulations, may also be used.
[0140] According to one exemplary embodiment of the present invention, the
system may comprise components of a software system. The system may operate on
a
network and may be connected to other systems sharing a common database. Other
hardware arrangements may also be provided.
[0141] Currently, most individual investors execute their investment
transactions
through brokers. The fund management business provides enormous revenues for
many
brokerage companies. This invention will likely be viewed as competitive with
ordinary
funds management, and inimical to many brokerage businesses. Brokerage firms
do not,
in general, have substantial balance sheets, and therefore are unlikely to be
large issuers
of structured notes.
[0142] Brokers not restricted by funds management conflicts, and independent
investment advisors are potential distribution forces for synthetic funds.
However, to be
successftil, synthetic funds will require development of large alternative
distribution
channels. The sale of synthetic funds will also require substantial investor
education.
[0143] The development of cash management accounts caused many individuals
to remove their funds from bank savings accounts and establish, for the first
time,
accounts with brokerage firms. The consequence has been an enormous growth in
the
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non-bank, brokerage and fund management industry. Today, banks represent a
very
small part of the consumer investment business.
[0144] One possible educational/advertising network for synthetic funds is a
consortium of banks, or other financial institutions interested in issuing
structured notes.
From a distribution perspective issuers' of structured notes, independent
investment
advisors, and other like minded parties could be organized to jointly develop
and leverage
educational materials, marketing, marketing collateral and advertising. Such
groups
could establish rules and standards that would inspire investor confidence,
share the cost
of advertising and promotions, share the costs of consumer education, etc.
[0145] Other embodiments, uses and advantages of the present invention will be
apparent to those skilled in the art from consideration of the specification
and practice of
the invention disclosed herein. The specification and examples should be
considered
exemplary only. The intended scope of the invention is only limited by the
claims
appended hereto.
[0146] While the invention has been particularly shown and described within
the
frameworlc of an invest product for consumers, it will be appreciated that
variations and
modifications can be effected by a person of ordinary skill in the art without
departing
from the scope of the invention. For example, one of ordinary skill in the art
will
recognize that certain investment processes and systems may be applied to
other
investment-oriented process in which valuation is not asset based.
Furthermore, one of
ordinary skill in the art will recognize that such processes and systems do
not need to be
restricted to structure notes.
