An Introduction to Certificated Products and AMCs - Part 3

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Is a Part 3 absolutely necessary?

Up to now the last two parts have worked through the origins, mechanics and pro’s and con’s of AMCs, Trackers and CLNs.

But having a breakdown of real use cases can help with putting all of this theory into context.

So in this part I am going to offer several examples of use cases of each Product type in the world of Certificated Products and AMCs, which I hope will give you more clarity and value.

This is the fun part.

Keep in mind that the examples I will show are not the only use cases; while they are some of the most common, other, and even more complex use cases can be structured.

AMCs

Example 1: Model Portfolio

Imagine you are a wealth manager, or a family office associate.

You have a book of high profile clients.

Yours is a multi-mandate: (i) preserve capital, (ii) beat inflation, (iii) grow capital.

To achieve these goals, you or your firm, have developed model portfolio’s.

(A model portfolio is an investment portfolio with a framework of asset allocation. It will define how much to invest in stocks, bonds or cash in order to achieve a certain goal, and is periodically adjusted to respond to market changes).

Normally you would take this framework and apply it to each of your client’s portfolios.

For client 1, you would buy: x amount of stocks, y amount of bonds and hold z amount of cash.

For client 2 you would do the same.

For client 3 you would do the same.

And so on for each of your clients.

Each client will incur trading costs, and you (or your portfolio managers) would spend the whole day (or maybe two) executing trades on each of the client’s portfolios.

Needless to say this is expensive, time consuming, and let’s be frank: a genuinely miserable task.

Today, many wealth managers and family offices are using AMCs to solve for the drawbacks I just listed above.

The AMC becomes the model portfolio, build around the firms predefined framework of asset allocation.

Once the AMC is built, the wealth managers and family offices have their investors subscribe to the AMC and as soon as the trade settles successfully, the clients are immediately allocated to the model portfolio (the AMC), without needing any additional trades or further adjustments.

There is only one trade and only one cost.

How is this achieved?

The AMC is issued by a legal entity, such as a Special Purpose Vehicle (SPV).

Your client will subscribe to the AMC by purchasing AMC certificates.

With the cash raised from these subscriptions, the SPV will invest into a basket of assets that follows your model portfolio framework.

When a rebalancing event is needed, you will rebalance the securities portfolio of the SPV, and by doing so, all AMC investors are automatically exposed to the newly rebalanced model portfolio.

Example 2: Liquid Assets Portfolio

This example is very similar to the first, however the difference is in scope.

The same structure from the first example can be used by an Asset Manager / Investment Manager, looking to setup their own portfolio of liquid assets, but who cannot currently afford or justify the high upfront costs to setup a full fund structure.

As an Asset Manager you may have developed your own investment strategy, either as an actively managed portfolio, or an algorithmic strategy.

Your investment strategy is unique. You have back-tested it, you’ve run it against a paper portfolio (for those that don’t know, this is a portfolio that allows you to trade using fake money in real market conditions), you’ve even set up a portfolio with your own capital. The strategy works, it’s delivering great returns, and now it’s time to open your strategy to external investors.

Unless you’re an absolute rock star, let’s be honest and admit that attracting 100 million or more in seed capital as a first time manager, for a first time product with no track record, is highly unlikely.

More likely is you will be able to raise 2 million, 5 million or maybe even 10 million.

It’s a good amount of seed capital, but at this level, setting up a fund is just not realistic.

While the setup costs are incredibly expensive and the time to setup (I will refer to this as time-to-market) can be excruciatingly long; the ongoing costs themselves would easily erode your performance.

An AMC can be a great, cost effective alternative.

The segregated assets structure still creates that layer of separation and bankruptcy remoteness, similar to some fund structures, even though an AMC and a fund are completely different legal structures.

The SPV can have a trading and brokerage account opened with most of the major brokers, and the ISIN code of the AMC makes it very easy for investors to subscribe to the AMC.

The setup and ongoing costs of an AMC are much lower than a fund, and the time-to-market is measurably quicker.

You as the Asset Manager will act as the mandated agent of the SPV and be responsible for implementing and managing the investment strategy, which will be based on your proprietary investment strategy or trading algorithm.

Example 3: Fund Alternative

This is again a similar example to the first and second examples, but we are now expanding the universe of assets.

Our previous examples focused predominantly on liquid securities, traded via major brokers; but AMCs can and frequently are used to build a portfolio of illiquid, or non-bankable assets.

You are probably already thinking of Private Funds, and you would be correct; you can use an AMC to build a diverse portfolio of private funds, almost building a “fund-of-funds” AMC.

But this can be expanded further to include Private Equity, Private Credit and even Real Assets.

The basic structure remains very similar to the structure chart in example 1. What really changes is the scope of control of over the assets, especially when using a segregated assets structure.

This scope of control is a discussion for another article, but the key takeaway from this example is to already plant the seed that AMCs are not reserved only to the world of liquid assets.

Trackers

Example 4: Feeder or Access Certificates

If you remember from Part 2 in this article series, a Tracker is a rules based Product, meaning there is no active management of investor capital.

The term sheet of the Tracker will define the Universe of Assets as well as the predefined Asset Allocation.

This has the advantage of being able to build a passive investment offering, that could be compelling for many investors.

Let’s go back and consider Private Funds. They are a popular investment class, giving investors access to world-class Managers and sometimes very unique investment strategies, not available to the general public.

However, these Funds are expensive: they require a very large minimum subscription amount if you want to be invested into them, and their fee structures can be expensive and sometimes complex.

Here, unless you have a large amount of capital, economies of scale is really the only way to efficiently gain access to these Private Funds.

Many External Asset Managers and Family Offices setup Trackers to act as an aggregation vehicle.

These firms will engage with a Private Fund manager and obtain access or allocation to a prestigious, or sought after Fund.

They then start obtaining investment commitments from their own client base by telling them about the Fund opportunity, etc.

Where a single client could not afford, or maybe justify, a minimum investment amount of 1 million, the External Asset Manager or Family Office can obtain a total investment commitment across their book of clients of say 5 million - 10 million.

Suddenly, the Private Fund is now accessible and more affordable to everyone.

And even more importantly: an External Asset Manager or Family Office that can offer their client base unique investment opportunities and access, that other competitors can’t, is adding value to their clients and creating a real Unique Selling Proposition.

How does it work?

The structure is very similar to the AMC structure from Example 1; it is the SPV that ultimately becomes the Subscriber to the Private Fund(s).

The key difference lies in the fact that the Tracker is rules based.

For every investor subscription that is received, that cash must be invested according to a predefined asset allocation formula. It is not up to the discretion of the External Asset Manger or Family Office to decide each time how much to invest with whom.

If the Tracker is giving access to a single Private Fund, then all investor subscriptions gets subscribed to that Fund.

If the Tracker is giving access to a portfolio of Private Funds, then all investor capital gets subscribed to each Fund according to a predefined ratio, or percentage.

The External Asset Manager or Family Office charges fees not for active management, but rather for building the access to the opportunity.

Example 5: Private Equity Raise

Assume you are a founder, or a business operator, or even a capital allocator working on a new equity deal.

Raising equity is never an easy process, and for many, the process can feel like it’s mostly out of their hands.

Nobody likes the process of approaching several different potential investors, negotiating specific terms with each, as you try to determine how to strike the best balance between offering each investor what they want, without liquidating existing investors too much, and while trying to maintain control over your business.

I have seen many founders setup a Tracker as a way to simplify their equity raise structure.

Remember how the SPV is entity that purchases the assets.

In this case it is the SPV that purchases the equity capital - only one entity.

Founders use this element to their advantage by building an equity offering that would predominantly suit their capital stack.

The SPV doesn’t need to negotiate, it doesn’t really care.

The investors into the Tracker are not buying the equity, but what they are buying is a financial instrument that gives them exposure to the target company.

And again, the Tracker is rules-based; there is no burden of active management.

CLNs

Example 6: Private Credit / Non-Bank Finance

I have spoken a little about non-bank financing in the past. CLNs are a way of structuring debt capital finance, where a bank is never involved.

In my line of work, many clients need debt capital, for a range of reasons: working capital, capital expenditure (CAPEX), project finance, asset acquisition, etc.

Many do not approach banks, purely because many banks have become too expensive, lack commerciality and their conditions have become too onerous or one-sided.

Many clients obtain their debt capital from non-bank institutions. I’ve touched on why these institutions exist in a previous article, (Structured Finance - Why Should I Care?), so I won’t repeat that here.

However, although they land up being more commercial and willing to take on risk, these non-bank institutions are expensive.

In response, my clients now look to setup CLNs as a means to raise their own debt capital.

Like the Private Equity scenario from Example 5, the CLN is basically a wrapper onto of a private loan agreement, between (you’ve already guessed it) the client’s Borrowing company, and the SPV.

Like the Private Equity scenario, the client is free to design the loan agreement in a way that helps them gain the maximum amount of benefit; everything from loan amount, term to maturity and interest coupon, to payment frequency of interest, whether the capital is amortising or only paid at maturity, and whether interest is capitalized, etc.

In other words, for the sophisticated client this can become quite a flexible and powerful tool.

Once the loan agreement is wrapped into the CLN, the CLN becomes the financial instrument which investors are buying.

So what’s the benefit? Why not just go to your investors directly to raise the loan?

There are several benefits; the first is that the interest coupon that’s paid to investors on the CLN does not have to equal the interest that’s paid between the client’s Borrowing firm and the SPV (as Lender).

In fact, it never should be the same. Rather the CLN should always be paying less - this is called the Differential - and it is used to cover fees paid to maintain the CLN structure and to the CLN arranger (which in many cases is the client that setup the CLN in the first place).

Second, remember that the CLN carries an ISIN. For a traditional private loan, the loan agreement needs to be negotiated and agreed upon, and the Borrower and Lender must exchange identification documents, etc. In other words it can create a large administrative burden; one which investors would prefer to avoid.

The ISIN legally sidesteps all of this because investors subscribe to the CLN through custodian bank; they are not entering into a loan agreement, rather, they are buying a financial instrument not to different from buying a gold ETF.

Third, the CLN is a Certificated Product - there is nothing stopping a CLN investor from selling their Certificates to a willing buyer, and the transaction has zero impact on the overall CLN or the underlying loan agreement.

This flexibility is an added layer of comfort for investors, especially institutional ones.

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So, this is where I end the article.

As I said, this list is not exhaustive. It also does not cover all the complexities behind these structure.

This article is not meant to. Rather it’s meant to give you an idea of the use cases and the flexibility these Products offer.

If you do want to understand the complexities more, or you have an investment opportunity you want to structure, then get in touch with me directly and I will be happy to walk with you on your journey.