U.S. patent application number 10/987584 was filed with the patent office on 2005-05-26 for multi-asset participation structured note and swap combination.
Invention is credited to Sperandeo, Victor.
Application Number | 20050114251 10/987584 |
Document ID | / |
Family ID | 23053673 |
Filed Date | 2005-05-26 |
United States Patent
Application |
20050114251 |
Kind Code |
A1 |
Sperandeo, Victor |
May 26, 2005 |
Multi-asset participation structured note and swap combination
Abstract
A unitary investment instrument combining a swap and a
structured note, both of which provide multiple utilization of
capital. The unitary instrument has three performance components.
An investor invests in the issuer the principal amount of the
structured note component. The structured note provides its own
portfolio exposures as well as serving as collateral for the base
benchmark portfolio swap (alternatively, the base benchmark
portfolio exposure can be acquired through a separate collateral
deposit on the investor's own portfolio). The first component is a
benchmark portfolio, which in one preferred embodiment is a
financial or stock index such as the S&P 500 Stock Index. The
second component is an incremental benchmark portfolio keyed to the
same benchmark index and the third component is keyed to a passive
commodity index, having long and short positions, which in one
preferred embodiment is the Mount Lucas Management Commodity Index.
The instrument's passive commodity index exposure is established as
the product of a leverage factor and the amount of the benchmark
portfolio exposure; thereafter this exposure may be the product of
(1) a leverage factor and/or (2) the change in value of the overall
investment, the benchmark component and/or the commodity index
component. The basic return to the investor comprises the change in
value of the benchmark, the incremental benchmark and the passive
commodity index exposure over a predetermined period of time. The
structured note component of the investment instrument includes a
guarantee of the return of the investment principal; the swap does
not do so, but rather reflects the full risk of the benchmark
portfolio exposure. However, research indicates that the unitary
swap/structured note instrument has an unusually high probability
of outperforming the benchmark index across a wide range of market
cycles.
Inventors: |
Sperandeo, Victor; (Dallas,
TX) |
Correspondence
Address: |
CHALKER FLORES, LLP
12700 PARK CENTRAL, STE. 455
DALLAS
TX
75251
US
|
Family ID: |
23053673 |
Appl. No.: |
10/987584 |
Filed: |
November 12, 2004 |
Related U.S. Patent Documents
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Application
Number |
Filing Date |
Patent Number |
|
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10987584 |
Nov 12, 2004 |
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09275758 |
Mar 25, 1999 |
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Current U.S.
Class: |
705/36R ;
705/35 |
Current CPC
Class: |
G06Q 40/04 20130101;
G06Q 40/06 20130101; G06Q 20/102 20130101; G06Q 40/00 20130101;
G06Q 40/02 20130101 |
Class at
Publication: |
705/036 ;
705/035 |
International
Class: |
G06F 017/60 |
Claims
1-11. (canceled)
12. A method of investment utilizing a unitary swap and structured
note investment instrument, comprising the steps of: establishing a
predetermined time period for investment in the instrument,
selecting a notional performance portfolio for determining a return
to the investor, the performance portfolio comprising: (a) a
benchmark portfolio having a selected exposure amount, (b) an
incremental benchmark portfolio increasing the exposure amount in
(a), (c) a passive commodity index portfolio, of long and short
positions, in an amount substantially equal to the product of the
benchmark portfolio amount in (a) and a leverage factor of at least
100%, which together define a commodity index portfolio exposure
that reduces the risk while increasing the return of the
performance portfolio.
13. A method of investment utilizing a unitary swap and structured
note investment instrument as recited in claim 12 including the
step of establishing a principal invested in the structured note as
a collateral deposit for the swap component.
14. A method of investment utilizing a unitary swap and structured
note investment instrument as recited in claim 12 including the
step of establishing a separate collateral deposit for the swap
component.
15. A method of investment utilizing a unitary swap and structured
note investment instrument as recited in claim 12 wherein a portion
of the selected exposure amount is provided by the investor's own
portfolio and the commodity index portfolio exposure amount is
selected to be a notional component.
16. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 13,
further comprising the step of returning the principal invested in
the structured note to the investor by an issuer at the end of the
predetermined time period.
17. Method of investment utilizing a unitary swap and structured
note investment instrument as recited in claim 13, wherein the
principal comprises stocks, bonds, T-bills, cash, currencies,
mortgages, any other security, or a combination thereof.
18. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 12,
further comprising the step of releveraging the passive commodity
index portfolio to have an exposure in an amount which is a
function of the commodity index portfolio exposure and a second
leverage factor.
19. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 12
wherein the benchmark portfolio is keyed to an equity index.
20. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 19
wherein the equity index comprises the S&P 500 Stock Index.
21. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 12
wherein the passive commodity index portfolio is keyed to the
S&P Diversified Trends Indicator.
22. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 12
wherein the leverage factor is a function of the performance of the
passive commodity index portfolio over a selected period of
time.
23. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 22
wherein the leverage factor of the passive commodity index
portfolio is a first predetermined number if the passive commodity
index portfolio has had a specified return over a selected period
of time and is a second predetermined number if the passive
commodity index portfolio has not had the specified return over the
selected period of time.
24. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 23
wherein the first predetermined number is at least 100% and the
second predetermined number is greater than the first predetermined
number.
25. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 12
wherein the exposure of the incremental benchmark portfolio is less
than or equal to 20% of the selected exposure amount.
26. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 12
wherein the exposure of the incremental benchmark portfolio is less
than or equal to 50% of the selected exposure amount.
27. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 12
wherein the leverage factor is less than or equal to 150%.
28. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 12
wherein the leverage factor is at least 50%.
29. The method of investment utilizing a unitary swap and
structured note investment instrument as recited in claim 12
wherein the leverage factor is less than or equal to 300%.
30. An investment created in accordance with the method of claim
12.
31. A computer adapted to implement the method of claim 12.
Description
BACKGROUND OF THE INVENTION
[0001] One of the dilemmas of contemporary money management is
whether it is feasible, or worthwhile, to attempt to outperform
broad-based financial indices (typically equity or debt indices) in
managing a core portfolio over time. This question is of particular
importance to institutional money managers who are typically
evaluated on the basis of their performance compared to a
broad-based market index. One aspect of this question has been
whether the addition of non-traditional investment components to a
traditional portfolio of stocks and bonds can reliably improve the
risk/reward ratio of a portfolio by diversifying a portion of such
portfolio into assets likely both to perform positively over time
and in a manner generally non-correlated with the general debt and
equity markets.
[0002] Financial products have increasingly emphasized the value of
diversification. Modern Portfolio Theory has demonstrated that over
time a diversified portfolio, by reducing the incidence of major
drawdowns, can generate high cumulative returns with reduced
volatility (a commonly-used measure of risk), as compared to
conventional portfolios consisting of stocks and bonds.
"Non-traditional" investments are incorporated into an investment
strategy because they are likely to demonstrate a significant
degree of performance non-correlation to a "benchmark portfolio,"
typically the general equity and/or debt markets. By combining
non-traditional and traditional portfolio components, an "efficient
frontier" of investment performance can be developed in which the
addition of the non-traditional component increases returns while
also reducing volatility up to the point of the desired level of
portfolio efficiency (risk/reward ratio) and maximum
non-traditional exposure. In the case of instruments of the present
invention, the "efficiency" of the instruments designed pursuant to
the invention is in large part a function of the extent to and
consistency with which they outperform the selected financial
benchmark.
[0003] One of the difficulties in implementing the diversification
strategy of Modern Portfolio Theory has been to identify a reliably
non-correlated and positively performing non-traditional investment
instrument or class. Diversifying into a non-traditional investment
can reduce volatility but not ultimately benefit a portfolio if the
non-traditional investment is not profitable. In addition, many
non-traditional investments have not, in fact, proved to be
non-correlated with the broader markets, especially during periods
of market stress (when the risk control benefits of diversification
are potentially of the most importance).
[0004] Modern Portfolio Theory was developed in the 1950s. In the
early 1960s, published financial portfolio research demonstrated
that managed futures might serve as a non-traditional "asset class"
for purposes of diversifying a traditional portfolio in a manner
consistent with the tenets of such Theory. Since that time, while
futures/commodities have been increasingly accepted as a means of
diversifying traditional portfolios, the dominant approach to
incorporating futures into a portfolio has focused on the use of
managed futures--futures accounts actively managed by professional
"Commodity Trading Advisors" and "Commodity Pool Operators." The
futures markets provide efficient and leveraged access to a wide
range of potentially non-correlated assets. However, the
performance of managed futures products has been unreliable.
Whether managed on a discretionary basis or pursuant to computer
models, actively managed futures strategies have demonstrated
significant periods of under-performance. Furthermore, even when a
managed futures investment is successful, it is impossible to
predict with any confidence what its likely near- to mid-term
performance will be. This uncertainty means that it is impossible
to know whether any given non-traditional investment will be (1)
profitable and/or (2) non-correlated with an investor's benchmark
portfolio.
[0005] A related impediment to the efficient implementation of
Modern Portfolio Theory investment products through the use of
non-traditional investments is that non-traditional investment
portfolio managers typically regard both their strategies and their
market positions as proprietary and confidential. Uncertainty of
performance is combined with uncertainty as to holdings and methods
of strategy implementation. These uncertainties have caused many
institutions (especially those which believe that their fiduciary
obligations to their investors or beneficiaries require that they
have access to position data) to avoid non-traditional investments.
The "entry barrier" of not providing trade transparency is
heightened because most actively managed non-traditional strategies
are subject to a non-quantifiable "risk of ruin"--the possibility
of sudden and dramatic losses of a large percentage of an overall
portfolio. In today's market environment, this is a particularly
topical concern due to the massive and wholly unexpected losses
suffered by a number of non-traditional, "hedge funds" in 1998,
many of which had previously exhibited excellent risk/reward
characteristics. "Risk of ruin" is not generally considered to be a
component of traditional equity and debt investments, and can be
best monitored by "real time" knowledge of strategies and
positions.
[0006] Finally, non-traditional investment alternatives are
frequently highly illiquid. Many non-traditional strategies have a
statistically significant incremental likelihood of success the
longer the time horizon of the strategy cycle. This is especially
the case with relative value, quasi-arbitrage methodologies but is
characteristic of many non-traditional approaches. As a result,
many non-traditional investments require investment commitments of
12 months or longer, eliminating investors' ability to limit their
losses or adjust portfolio exposure by terminating or reducing
their investment.
[0007] The present invention provides a non-traditional investment
instrument which eliminates the illiquidity and trade
non-transparency, as well as a substantial component of the
unpredictability, of many alternative non-traditional investments
and which has produced consistently successful and non-correlated
performance over 38 years of researched price histories.
[0008] The present invention is directed in particular at combining
a swap instrument which achieves full exposure to a benchmark index
and a structured note which adds to the overall unitary instrument
structured pursuant to this investment both (i) an incremental
exposure to the selected benchmark index, plus (ii) exposure to a
passive, long and short, commodity index. The incremental exposure
to the benchmark index provides the potential to outperform this
index in favorable periods, while the commodity index exposure
provides potentially valuable diversification benefits by providing
access to a non-traditional exposure which avoids or reduces the
illiquidity, trade transparency and unpredictability typical of
actively managed non-traditional investments.
[0009] Many traditional money managers are evaluated in large part
on the basis of their ability to match or exceed a benchmark index.
Instruments of the present invention provide such managers with
full exposure to their benchmark index through a swap on such
index, plus incremental exposure to such index through the
component of the structured note which is itself keyed, in part, to
such index, while also providing an exposure to a passive commodity
index of long and short positions. The incremental benchmark index
exposure can permit instruments of the present invention to
outperform the benchmark index when it is moving upwards. In fact,
it would only be if the passive commodity index not only
underperforms but incurs losses equal to or in excess of the
incremental benchmark exposure that the unitary instrument would
not outperform. In addition, the passive commodity index component
of the structured note, by providing diversification from the
index, provides a return which can permit the instrument to perform
profitably when the index is declining, potentially contributing
significantly to cumulative outperformance of the index by the
unitary swap/structured note instrument. The use of the structured
note also limits the overall risk of instruments of the present
invention, as the structured note assures the investor the full
return of the principal invested in such note after a specified
period of time.
[0010] In historical simulations, the combination of a swap on one
preferred embodiment of the selected benchmark for the
invention--the S&P 500 Stock Index--and a structured note
combining a 20% incremental exposure to the S&P 500 plus an
exposure of 100%-150% to the Mount Lucas Management Commodity Index
(percentage figures, in each case, are of the total amount invested
in the instrument) has outperformed the S&P in all rolling 8
year periods (the duration of one preferred embodiment of
instruments of the present invention) since 1961 to a significant
degree.
SUMMARY OF THE INVENTION
[0011] The present invention is a unitary investment combining a
swap instrument and a structured note. The swap creates a market
exposure indexed to a benchmark selected by the investor to reflect
the investor's portfolio needs and objectives. Because this market
exposure is achieved through the use of derivatives, it can be
supported entirely by the collateral of the structured note; it can
also be based on a deposit of a small amount of collateral
specifically designated for the swap; however, using the structured
note itself as collateral for the swap--as well as an independent
source of rate of return--is the preferred embodiment of
instruments of the present invention, permitting a double
utilization of capital. The swap provides a return to the investor
equal to the benchmark index selected. This benchmark index
exposure is combined with a structured note which adds an
incremental exposure to the benchmark index as well as exposure to
a passive commodity index portfolio of long and short positions.
The passive commodity index portfolio creates an exposure in an
amount substantially equal to the product of the benchmark
portfolio exposure of the swap multiplied by a leverage factor
which together defines a commodity index portfolio exposure. The
commodity exposure may be subject to periodic leverage adjustment.
The return to the investor comprises substantially the change in
value of the benchmark portfolio exposure obtained through the
swap, the incremental benchmark portfolio exposure obtained through
one component of the structured note and the commodity index
portfolio exposure obtained through the other component of the
structured note, in each case over a predetermined period of time.
Investors are generally guaranteed the return of the principal
invested in the structured note as of the end of a specified time
period.
BRIEF DESCRIPTION OF THE DRAWINGS
[0012] For a more complete understanding of the present invention
and the advantages thereof, reference is now made to the following
description taken in conjunction with the accompanying drawings in
which:
[0013] FIG. 1 is a block diagram illustrating a swap/structured
note instrument in accordance with the present invention,
[0014] FIG. 2 is a block diagram illustrating the possible periodic
leverage adjustment mechanism to the passive commodity index
component of the swap/structured note instrument as well as how the
performance of the instrument in one time period is compounded into
its performance in the next.
DETAILED DESCRIPTION
[0015] The preferred embodiments of the present invention utilize
two well-established and independently maintained financial indices
(although it is not necessary that a financial index be used as the
benchmark). These are the Standard & Poor's 500 Stock Index
(referred to as the "S&P") of large capitalization U.S. stocks
and the Mount Lucas Management Commodity Index (referred to as the
"MLM").
[0016] The S&P is a widely-used index. It is employed in the
preferred embodiments of the present invention rather than the (at
least) equally familiar Dow Jones Industrial Average due to the
significantly greater liquidity of derivative instruments available
on the S&P. This liquidity is important to the design of
instruments of the present invention because the banks and dealers
which may issue these instruments reflect market liquidity (which,
in turn, is directly reflected in the costs incurred by such banks
and dealers in hedging their risks under the present invention
instruments) in the pricing of such instruments. The higher the
hedging transaction costs imposed on the issuers of the subject
instruments, the lower the efficiency of these instruments to the
investor.
[0017] The MLM tracks 25 different commodities/futures including 6
currencies, 3 U.S. bonds and 16 traditional commodities
(collectively, the "MLM Objects"). The MLM is an unleveraged index
which has been analyzed over 38 years of price histories and has
been used to manage institutional accounts since 1993. It is
comprised of long and/or short positions in each of the 25 MLM
Objects, each with an equal dollar value, rebalanced monthly. All
MLM positions are established as long or short on the basis of a
straightforward trend-following model as of the beginning of each
month and held until month-end; no trades occur intra-month. A long
position is taken if the current spot price is above the average
month-end spot price during the past 12 months (indicating an
upward price trend); otherwise a short position is taken. There is
no discretionary input into the MLM; consequently, it can be
mathematically applied to historical market data to generate
researched price histories.
[0018] The MLM does not function as an all long commodity price
index. On the contrary, because it acquires both long and short
positions in the various MLM Objects, the performance of the MLM is
substantially non-correlated to overall commodity prices, adding a
further dimension to the diversification of the instruments of the
present invention.
[0019] The present invention creates, not by active management but
by the application of a passive index, a non-traditional portfolio
component which has a statistically very high likelihood of
exceeding the performance of the selected benchmark through a wide
range of different market conditions and economic cycles. The MLM
is an unusual type of passive index in that unlike the standard
commodities indices--the Commodity Research Bureau Index and the
Goldman Sachs Commodity Index--the MLM takes both long and short
positions in the different MLM Objects. In historical simulations,
as well as actual institutional account performance since 1993, the
results of the MLM have substantially outperformed the all-long
commodities indices as well as exhibiting significantly greater
diversification effects when combined with the S&P. Moreover,
combinations of the MLM and the S&P, structured in accordance
with the present invention, have yielded returns and risk control
parameters substantially superior to the S&P considered on a
stand-alone basis over periods of time generally consistent with
institutional investment time horizons (8 years is one preferred
embodiment of the instruments of the present invention), as well as
substantially superior to many alternative combinations of
non-traditional and traditional investments. In addition, even
brief periods of underperformance were rare. Furthermore, due to
the liquidity of the MLM Objects and the resulting ease with which
the MLM can be hedged, the present invention can be provided by a
large number of different banks and dealers on competitive economic
terms.
[0020] An index of the type represented by the MLM is referred to
herein as a passive, long and short, commodity index. The essential
aspects of such an index are that (1) it is primarily based on
commodities, (2) it is passive, which means it is determined by a
formula rather than active management, and (3) it takes both long
and short positions.
[0021] The use of a passive index eliminates any uncertainty as to
how instruments of the present invention will perform under any
given market scenario while also allowing total transparency of
trading positions and strategies. In addition, the present
invention is able to adjust to a wide range of different end-user
risk/reward tolerance levels by permitting wide flexibility in
adjusting both initial leverage and the ratio of the benchmark
portfolio exposure (both base and incremental) to the instrument's
passive, long and short, commodity index portfolio exposure. Once
initially calibrated, instruments of the present invention perform
robotically in accordance with the performance exposure and risk
components designed into the initial parameters, although they can
be varied if so desired by the investor during the term of the
investment.
[0022] Investment instruments pursuant to the preferred embodiments
of the present invention are internally diversified when considered
as a stand-alone (unitary) investment, each combining the S&P
and the MLM. In addition, the overall investment instrument
represents a diversification from traditional portfolio components.
Specifically, however, the present invention has been directed to
meeting the portfolio objectives of institutional money managers
who are themselves focused on outperforming (or at least not
underperforming) a particular financial index. The unitary
combination of the swap and structured note in instruments of the
present invention is particularly designed to outperform the
selected benchmark due to the instrument's incremental benchmark
exposure (as well as the potentially profitable exposure of the
instrument's passive commodity index) in favorable markets and
through its potentially non-correlated passive commodity index
performance in unfavorable benchmark markets.
[0023] Investors may be able to redeem investments of the present
invention at any time (subject to the imposition of a redemption
charge in the case of the structured note component of the unitary
investment instrument). The ability to redeem combined with total
trade transparency provides investors with a layer of risk control
unavailable in most non-traditional investment alternatives.
[0024] Because of the passive character of the indices incorporated
in the present invention, it is also possible to fix the costs
applicable to these instruments at the time each instrument is
designed. Changes in market conditions subsequent to product
inception have no effect on the pricing to the investors. This
eliminates the risk that a material increase in market volatility
(and, accordingly, the hedging cost to the issuer of an instrument
of the present invention) will result in a commensurate increase in
embedded costs, and corresponding degradation of investment
potential. Actively managed non-traditional investments, on the
other hand, can be subject to extreme variability of costs, a
feature which is especially unacceptable to institutional investors
when they are denied access to the trade information necessary to
monitor the actual level of transactions being executed.
[0025] The performance of the MLM cannot be predicted in the
abstract; however, given any assumed market movements, this
performance can be determined with high probability. This enables
investors to apply market sensitivity analysis--a basic method of
quantifying market risk exposure--to the positions held by the
instruments of the present invention with a high degree of
accuracy. On the other hand, it is not possible to conduct reliable
market sensitivity, "value at risk" or Monte Carlo simulation
market exposure analysis on most actively managed alternative
investment products. The "risk of ruin" in instruments of the
present invention can be clearly quantified; in most
non-traditional investments it is effectively unknowable.
[0026] Statistical analysis also indicates a remarkably high degree
of non-correlation between the S&P, as well as other securities
market indices, and the MLM throughout a wide range of different
market cycles.
[0027] The use of the MLM in combination with an investor's
benchmark index addresses many of the difficulties encountered to
date in incorporating non-traditional investments as a "mainstream"
component of traditional portfolios, while also designing a
non-traditional investment specifically adopted to institutional
investors' need to outperform (or at least not underperform for any
significant period) selected financial indices.
[0028] FIGS. 1-2 generally indicate a progressive time period going
from the top to the bottom of each Figure. The base benchmark
exposures, the incremental benchmark exposure and the passive, long
and short, commodity index portfolio exposure are separated
horizontally although they are part of the unitary investment
instruments of the present invention.
[0029] Referring to FIG. 1, there is illustrated a swap/structured
note instrument 20 in accordance with the present invention. The
instrument 20 comprises a swap component and a note component. The
swap component comprises a base benchmark portfolio exposure 24.
The note component comprises an incremental benchmark exposure 28
and a passive, long and short, commodity exposure 30. An investor
who wishes to utilize the swap/structured note instrument 20 with a
specified face amount invests that amount as investment principal
26 in the structured note. The structured note at once serves as
collateral for the swap component and as the investment in the
note. The base benchmark portfolio exposure 24 is acquired through
the swap (further described below). The initial base benchmark
portfolio exposure 24 is generally equal to the face amount of the
instrument 20.
[0030] The preferred method of financing the instrument 20 is for
the investor to provide the investment principal 26 in a dollar
amount to equal the note component which in turn provides full
collateral to the swap component, which is of equal face value to
that of the note component.
[0031] An investor may select to provide separate collateral, such
as a part of his own portfolio, for the swap component of the
instrument 20 with separate investment principal for the note
component.
[0032] The issuer of the structured note (typically also the issuer
of the swap) guarantees the return of the investment principal 26
as of the end of a specified period (8 years in one preferred
embodiment). The investment principal 26 is used to acquire the
incremental benchmark portfolio exposure 28 and the passive long
and short commodity index exposure 30 which is equal to the
benchmark portfolio exposure 24 multiplied by a leverage factor
L.sub.1. An overall structured note exposure 32 comprises
incremental benchmark portfolio exposure 28 and commodity index
exposure 30.
[0033] The return provided to the investor is measured by a
performance exposure portfolio which comprises the benchmark
portfolio exposure 24 and the combination of the incremental
benchmark portfolio exposure 28 and the passive, long and short,
commodity index exposure 30. The face amount of the benchmark
portfolio exposure 24 is identified by the term P.sub.1. The face
amount of the passive commodity index exposure 30 is the product of
a leverage factor L.sub.1 and the benchmark portfolio exposure 24
(P.sub.1). The face amount of the incremental benchmark portfolio
exposure 28 is a fraction of the benchmark portfolio exposure 24
(in one preferred embodiment, 20%).
[0034] The leverage factor L.sub.1 is determined by a formula that
is based on the performance of the selected commodity index used
for the commodity exposure 30. If the commodity index performance
in the preceding 12 months (or other period of time) equaled or
exceeded 15% (in the case of the MLM under market conditions in
late 1998; using a different commodity index and/or under different
market conditions, this figure could vary from 15%), L, is selected
to be 100%, but if the total performance of the selected commodity
index is less than 15% during the preceding 12 months (or other
period of time), the leverage factor L, is selected to be 150%.
These are preferred leverage factors, but other leverage factor
values may also be used.
[0035] The swap/structured note instrument 20 includes a
predetermined time period 34 which preferably is one year.
Typically, the instrument 20 is not terminated at the end of one
year, but is reset as further described with reference to FIG.
2.
[0036] The initial performance portfolio for the swap instrument 20
comprises the benchmark portfolio exposure 24, the incremental
benchmark portfolio exposure 28 and passive, long and short,
commodity index exposure 30. After the time period 34 has elapsed,
the final performance portfolio comprises a final benchmark
portfolio exposure 36 and a combination incremental benchmark
portfolio and a passive, long and short, commodity index exposure
44. The base benchmark portfolio exposure 36 has two components
which are the initial base benchmark portfolio 24 and a value
change 24a. The structured note exposure 44 has four components
which are the initial incremental benchmark exposure 28, a value
change 28a for exposure 28, the initial commodity index exposure
30, and a value change 30a for exposure 30.
[0037] The combination of exposures 28 and 28a comprises an
exposure 38. The combination of exposures 30 and 30a comprises an
exposure 40.
[0038] The return for the time period 34 has three components. The
first comprises the base benchmark portfolio value change 24a,
which is expressed as the term .DELTA.V.sub.B1. The second
comprises the incremental base benchmark portfolio value change 28a
which is expressed as the term .DELTA.V.sub.B2, and the third is
the passive, long and short, commodity index value change 30a,
which is expressed as the term .DELTA.V.sub.C1. Thus, the return on
the swap instrument 20 for the time period 34 is represented by the
sum of .DELTA.V.sub.B1 plus .DELTA.V.sub.B2 plus
.DELTA.V.sub.C1.
[0039] At the end of the time period 34, the passive commodity
index exposure 40 of structured note (indicated as 20') is subject
to releveraging as illustrated in FIG. 2.
[0040] The amount of investment principal 26' as of the beginning
of time period 46 equals the initial investment principal 26 plus
.DELTA.V.sub.B1, plus .DELTA.V.sub.B2, plus .DELTA.V.sub.C1.
Although the base benchmark portfolio exposure has increased by
.DELTA.V.sub.B1, the increase in investment principal provides
adequate collateral for this increased exposure.
[0041] The initial base benchmark portfolio exposure 36 as of the
beginning of time period 46 is the final benchmark portfolio 36 at
the end of time period 34. Similarly, the initial incremental
benchmark exposure 38 as of the beginning of time period 46 is the
final incremental benchmark exposure 38 at the end of time period
34. The final passive commodity index exposure 40 (from FIG. 1) is,
however, subject to releveraging at the beginning the second time
period 46.
1TABLE 1 UNITARY SWAP/STRUCTURED NOTE INSTRUMENT MARKET SECTOR
ALLOCATIONS Percentages Are of Total Portfolio Exposure S&P
(Benchmark Portfolio; assumes 20% Incremental Benchmark Exposure)
Equities 54.0% 44.0% (Base Benchmark plus Incremental Benchmark)
MLM (Passive, Long and Short, Commodity Index Portfolio) 100%
Leverage 150% Leverage Bonds 5.46% 6.68% Currencies 10.92% 13.35%
Energy 7.28% 8.89% Grains 9.10% 11.11% Other Agricultural 7.28%
8.89% Metals 5.46% 6.68% 100.00% 100.00% Percentages are of amounts
invested in the unitary swap/structured note instrument.
[0042] The releveraging to produce the commodity index exposure 42
at the beginning of time period 46 is effected using the same
formula utilized initially to determine the leverage factor for the
commodity index exposure 30, as described above in reference to
FIG. 1. The ending value of the passive commodity index portfolio
40, represented by CP.sub.2, is divided by the leveraging factor L,
used at the beginning of time period 34 to calculate a "unit" of
passive commodity index exposure. That unit is then multiplied by
the new leverage factor L.sub.2, determined as previously
described, to establish the commodity index portfolio exposure 42
for time period 46. For the present example, the initial leveraging
factor applied in determining the commodity index exposure 30 is
referenced as L.sub.1, which may be assumed to be 100%. If the
newly-calculated leverage factor L.sub.2 is assumed to be 150%,
then the passive commodity index exposure 42 will be 1.5 times as
large as the passive commodity index exposure 40 and also greater
than the initial passive commodity index exposure 30 (barring a
greater than 1/3 loss in the passive, long and short, commodity
index exposure in time period 34). If the value of the passive
commodity index portfolio exposure 40 is represented by CP.sub.2,
the passive commodity index exposure 42 is determined by the
formula, exposure 42=(L.sub.2.times.CP.sub.2+L.sub.1). If L.sub.1
and L.sub.2 are respectively 100% and 150%, then the value of
exposure 42 will be 1.5.times.CP.sub.2. Should the original value
of L.sub.1 be 150% and L.sub.2 be 100%, then exposure 42 will be
0.66% of CP.sub.2.
[0043] Upon expiration of the second time period 46, there is a
value change 36a (.DELTA.V.sub.B3) in the base benchmark portfolio
exposure 36, a value change 38a (.DELTA.V.sub.B4) in the
incremental benchmark portfolio exposure 38 and a value change 42a
in the commodity index portfolio exposure 42.
[0044] After the expiration of the time period 46, there is
produced a final benchmark portfolio exposure 48 includes the basic
component exposure 36 and a value change 36a, which is represented
by the term .DELTA.V.sub.B3. Similarly, following the completion of
time period 46, there is produced an incremental benchmark
portfolio 50 having a basic component 38 and a value change 38a
.DELTA.V.sup.B4 and a final passive, long and short, commodity
index exposure 52 comprising the basic component exposure 42 and a
value change 42a, which is represented by the term .DELTA.V.sub.C1
The combination of exposures 50 and 52 is a final structured note
exposure 54.
[0045] The return to the investor over time period 46 equals
.DELTA.V.sub.B3 plus .DELTA.V.sub.B4 plus .DELTA.V.sub.C2.
[0046] The leverage factor applied to generate the commodity index
exposure 42 can be constant, the same as was applied to generate
commodity index exposure 30, or it can be the result of the changes
in the leverage factor effected periodically over the life of the
note instrument 20' with releveraging performed as described above
in reference to FIG. 2.
[0047] The note component of the instrument 20 can have a payout
factor which can be 100%, or more or less than 100%, of the
notional changes 28a and 30a. The payout factor is set at the
initiation of the instrument 20. The payout factor number generally
depends on the volatility of the underlying basis and nominal rates
at the time.
[0048] A numerical example of an instrument of the present
invention is as follows.
[0049] Assume that $10 million is invested in the unitary
swap/structured note instrument 20, this $10 million is the
investment principal 26 which is invested in the structured note
exposure 32 as well as serving as collateral for the swap component
(exposure 24).
[0050] The initial base benchmark portfolio exposure 24 (P.sub.1)
would represent a $10 million S&P exposure in one preferred
embodiment of the present invention. Similarly, the incremental
benchmark portfolio 28 could represent a $2 million S&P
exposure in such embodiment. Assuming that the initial leverage
factor L.sub.1 is 100%, the initial passive long and short
commodity index exposure 30 would be $10 million.
[0051] If during the initial time period 34 the S&P exposure 24
increases 10% and the MLM exposure 30 increases 5%, the value
change 24a in the base benchmark portfolio exposure 24 would be $1
million and the value change 28a in the incremental portfolio
exposure 28 would be $0.2 million. The value change 30a in the
passive commodity index exposure 30 would be $0.5 million.
Consequently, the total return to the investor in time period 34
would be $1 million (.DELTA.V.sub.B1), plus $0.2 million
(.DELTA.V.sub.B2) plus $0.5 million (.DELTA.V.sub.C1), for a total
of $1.7 million. The value of exposure 40 at the end of time period
34 is $10.5 million.
[0052] At the beginning of time period 46 the base benchmark
portfolio exposure 36 would equal $11 million, and the incremental
benchmark portfolio exposure 38 would equal $2.2 million. Assuming
that the leveraging factor applied to the passive long and short
commodity index portfolio 40 (CP.sub.2) as of the beginning of time
period 34 was L.sub.1 rather than L.sub.2 and that L.sub.2 was 150%
rather than 100%, the releveraged commodity index exposure 42 would
equal 150% (L.sub.2).times.$10.5 million (CP.sub.2).div.100%
(L.sub.1), or $15.75 million. The overall exposure 44 of the
structured note component would, accordingly, equal the incremental
benchmark portfolio exposure 38 of $2.2 million plus $15.75 million
42, or $17.95 million.
[0053] If in the time period 46 the S&P exposure 24 increases
5% and the MLM exposure 30 increases 10%, the value change 36a in
the base benchmark portfolio 36 would equal $0.55 million, the
value change 38a in the incremental portfolio exposure 38 would
equal $0.11 million and the value change 42a in the releveraged
commodity index exposure 42 would equal $1.575 million.
Consequently, the total return to the investor over time period 46
would be $0.55 million (.DELTA.V.sub.B3) plus $0.11 million
(.DELTA.V.sub.B4) plus $1.575 million (.DELTA.V.sub.C2), or $2.235
million. The new base benchmark portfolio exposure 48 would equal
$11.55, the new incremental benchmark portfolio exposure 50 would
equal $2.31 million and the new passive long and short commodity
index exposure 52 would be $12.075 million (subject to releveraging
as of the beginning of a time period 3).
[0054] The return of $2.235 million is based on a payout factor of
100%. Had the payout factor been different, the return would be
changed proportionately.
[0055] If a unitary swap/structured note instrument is held to
maturity, an investor will receive back not only the performance of
the instrument (.DELTA.V.sub.B1 plus .DELTA.V.sub.B2 plus
.DELTA.V.sub.C1 in time period 34; .DELTA.V.sub.B3 plus
.DELTA.V.sub.B4 plus .DELTA.V.sub.C2, in time period 46, etc.), but
also the amount of the original investment principal 26, however,
losses can result in a loss of principal from the base benchmark
portfolio exposure 24.
[0056] A reporting and accounting system can provide daily and
intra-day trading positions and net asset value information
directly to investors, as well as calculating all fees embedded in
the investment instruments.
[0057] It is not necessary that the investor acquire the "benchmark
portfolio" (base or incremental) component of the investment
instrument as a part of the instrument itself. The benchmark
portfolio may comprise a pre-existing portfolio held by an
investor. Furthermore, an investor need not maintain a static
benchmark portfolio during the term of the investment instrument.
Changing the make-up of the benchmark portfolio will affect the
overall results achieved, but this is not inconsistent with the
invention.
[0058] The investment instruments of the present invention may be
evaluated by portfolio managers as internally diversified,
stand-alone investments as well as in terms of constituting
non-traditional investment alternatives providing the potential for
diversifying a traditional portfolio. These instruments are also
specifically designed for portfolio managers who are directed
towards equaling or exceeding the performance of a given
(typically, but not necessarily, financial) benchmark. One of the
preferred embodiments of the instruments of the present invention
is an 8 year instrument combining the S&P and the MLM; this
embodiment has outperformed, in historical price research, the
S&P in all rolling 8 year periods since 1961.
[0059] The parties involved in structuring the swap/structured note
instruments, marketing these instruments, consulting and managing
the releveraging processes (and possible recalibrating or
rebalancing decisions), monitoring net asset values and issuing the
swap/structured note instruments will receive a variety of fees
from the investors. In certain cases, these fees may be paid
directly by investors, outside of their investment in an
instrument; in other cases, these fees will be deducted from the
amount invested. These fees may include percentage fees based on
the benchmark exposure of an instrument, or only on the commodity
index component thereof, as well as percentage fees based on the
actual Net Asset Value of the instrument. Percentage fees may
generally be assumed to range up to 3% per annum in total, but will
vary on a case-by-case basis. Incentive fees based on the
performance of an overall instrument, calculated either
periodically or over the entire term of the investment, may also be
charged, and may be calculated over a hurdle rate reflecting the
performance of the benchmark portfolio. These fees may generally be
assumed to range from 15%-25%, but will vary on a case-by-case
basis. There will also be a monthly charge to reflect the issuer's
costs of adjusting its hedges to reflect the monthly internal
rebalancing of the MLM by executing the corresponding trades in the
futures markets. A licensing fee of approximately 0.5 of 1% per
annum is also payable for the use of the MLM, and, in the case of
the structured note component of the instrument, there is an
indirect cost in the form of the loss of any interest earned on the
investment principal (investors being guaranteed only the return of
the principal of the structured note component, not any interest,
as of the maturity date).
[0060] All fees and charges are subject to individual negotiation,
as well as in the case of certain fees, to market conditions at the
time an instrument is issued. For example, the monthly charge
reflecting the hedging costs associated with the MLM's internal
rebalancing as well as the payout factor are both directly affected
by market volatility.
[0061] Although several embodiments of the invention have been
illustrated in the accompanying drawings and described in the
foregoing Detailed Description, it will be understood that the
invention is not limited to the embodiments disclosed, but is
capable of numerous rearrangements, modifications and substitutions
without departing from the scope of the invention.
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