Using the technique of securitisation to unlock access to otherwise hard-to-enter investments was the theme of a recent Breakfast Briefing hosted by this news service.

Securitisation is a liberator, a tool to unlock otherwise hard-to-access returns from areas such as hedge funds and private equity, a recent Breakfast Briefing event, hosted by the publisher of this news service, heard. (To see full details of the event, click here.)

The quality of a security instrument is ultimately as good or as weak as the underlying asset upon which it is based; if the assets are robust, securitisation has a valuable role to play and can break down certain restrictions, the briefing, held in the Carlton Club in London’s St James’s district, was told.

Delegates attending the event were told of how holdings of alternative investments can be used as collateral and securitised, with the securities listed on an exchange and thereby eligible to be held in the kind of funds that might otherwise be off limits for alternative assets because of liquidity requirements and other tests. 

This message was given by Argentarius, a European firm specialising in creating securitisations where alternative portfolios are the reference asset. The briefing was kicked off by Andreas Wölfl, who founded Argentarius Group. In 2004 he set up the group by securitising an offshore hedge fund into a transferable security; in 2007 he entered the private label market by creating a securitisation platform in Luxembourg. Subsequently, the firm has set up headquarters in Malta; the first exchange traded instrument was listed on the Deutsche Börse exchange in Frankfurt in 2013.

Besides Wölfl, other speakers were Lorraine Homewood, client director, Connection Capital; Tim Smith, head of fixed income at Stamford Associates, and Nick Cowan, managing director of GSX Limited. The panel was chaired by Margie Lindsay, editor, Alpha Journal. The event was sponsored by Argentarius.

How it works
Explaining the mechanics, Wölfl said an alternative investment portfolio, like a private equity fund, is placed into a special purpose vehicle (SPV); the SPV issues bonds, the performance of which are linked to the underlying value of the portfolio’s assets; a securitisation cell company is formed and securities are linked on a stock exchange, such as Germany’s Deutsche Borse or Gibraltar’s GSX exchange. The securities, because they are tradable, are eligible to be held in a passportable retail fund such as a European UCITS structure. One benefit, for example, is that a hedge fund domiciled outside the European Union can be securitised, enabling the former’s investment returns to be made available to EU clients. At present, regulations such as the EU’s Alternative Investment Fund Managers Directive place limits on how investment vehicles can be sold to EU investors by non-EU firms. Securitisation not only unlocks the door but simplifies the process.

One issue is that under certain rules, banks cannot act as custodians for non-bank assets but securitisation “can help them fulfil these [custodian requirements]”, Wölfl said. He also gave the case of a US manager of a Cayman Islands-based fund who wanted to tap EU investors – the securitisation option enables this to happen. Securitisation is a “different kind of feeder fund”, Wölfl said.

During the discussion, Stamford Associates’ Smith said that securitisation “is all about risk transfer” and stressed that any evaluation of securities must be based upon clear information about the assets in a portfolio and the visibility and reliability of cash flows from those assets. He said securitisation has been given a bad name in some quarters, arguing that the kind of securitisation based on a single, transparent set of assets is very different from the multi-layered mix of strong, moderate-risk and high-risk assets seen in structures such as collateralised debt obligations that suffered massive losses from the US sub-prime mortgage debacle.

Wölfl noted that a recent problem for many small and medium sized enterprises (SMEs) has been lack of access to bank credit for routine short-term credit facilities; securitisation creates new access to credit, he said.

Connection Capital’s Homewood said the issue of transparency of securitisations is “absolutely paramount” for investors, who will want to see full disclosure on fee structures and costs. One concern people have had about certain forms of alternative investment, she said, is that they “don’t want to be held in structures for years and want more flexibility”; she said securitisation offers a more flexible way to play alternative asset classes.

Cowan said the GSX sets clear requirements around transparency of securities listed on it; “we are very interested in the underlying risks and in transparency and we want to be sure we get to the heart of a risk,” he said.

Asked why wealth managers would be interested in such securitisation, Smith said it opens market areas that are tough to enter. He gave the example of the leveraged loans market, one which is typically only accessible by professional investors and specialists, not private clients. “This is a very stable asset class in terms of generating income,” he continued. Given their characteristic of uneven liquidity, leveraged loans can’t be held currently in a UCITS fund, but securitisation would open the way, he said.

On the risks side, Smith said a key requirement is for advisors and managers to closely monitor the quality of the assets underpinning securities.

GSX’s Cowan was asked if Gibraltar has capacity to list such securities, and he responded with an emphatic “yes”. “Before Argentarius [listed a security] Gibraltar had not listed an exchange traded instrument before.”

Homewood said she does not see such securities being particularly strong in a retail market because “many investors won’t yet understand a lot of these transactions...these are more for sophisticated investors who understand what they are buying.”

Wölfl added that at a time when about half of German government bonds [aka bunds] are suffering negative yields, a thirst for returns meant that a market for securities able to tap higher-yielding assets will be very attractive.

Stamford’s Smith added: “Remember, what you are buying here is a set of underlying cashflows.”