Japanese investors, both retail and institutional, have traditionally invested in fixed income products or long-only equities. However, when interest rates fall, it is natural for investors to look at investing into a diverse range of investment products to generate revenue and/or protect capital. It therefore came as no surprise when, earlier this year, the worldwide news feeds were alive with stories confirming that Japanese investors were moving into non-domestic structured products due to negative interest rates and domestic sovereign bond yields sitting below zero.
So what are structured products? Structured products always seem to hold a perception of complexity and mystique, which historically has persuaded all but the most sophisticated investors to invest in them. However, the term “structured product” simply relates to a structure that is established to follow a pre-packaged investment strategy. Often this can be based on derivatives, such as a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies – quite often packaged through notes or swaps.
Unfortunately for the domestic retail investor, access to alternative investment products can be difficult due to factors such as minimum investment size, language barriers or the ability to gain access to non-domestic funds. Further, regulation does not allow for retail investors to invest directly into derivative structured products created by investment banks or active managers. And it is predominantly investment banks or active managers that create these structures.
Fortunately, there is a solution: a collective investment structure called an offshore unit trust.
The investment bank creates the derivative-based structured product and partners with a Japanese securities company (the “distributor”), which has a wide pool of clients from which to fund-raise. Both parties benefit as the investment bank can raise funds from the securities company’s clients, while the securities company can offer their clients an alternative investment strategy to fit with their needs.
To fulfil regulatory requirements in order to allow domestic Japanese retail investors the opportunity to invest in the product, a feeder structure is created using an offshore (predominantly Cayman Islands) collective investment scheme, which then invests in the derivative products.
The most common vehicle utilized for this purpose is a Cayman Islands domiciled unit trust, which has the inherent qualities of a fund – it may pool investments from many investors, spread risk and provide diversification. Importantly, the Cayman unit trust and the underlying fund into which it invests are not controlled by the investors.
Units can be bought (subscribed) and sold (repurchased) at a prevailing price (the net asset value per unit) and, depending on the liquidity requirements, the fund price can be issued daily, weekly or monthly. Investors can recognise the investment and returns in the unit trust without having to concern themselves with the disclosures and pricing associated with the underlying derivative-based portfolio.
Structured products should not be simply regarded as high-risk products; they are often created using a strategy suitable for careful investors looking for higher returns than standard deposits. Indeed, Japanese retail investors are cautious and want to protect their capital, and many invest in publicly offered structured products (offered via the large distributor companies) due to the liquidity they provide and the ability to receive regular monthly income.
Moore Management has been providing offshore unit trust structures to Japanese investors since 1996. We take care of all aspects of running the unit trust, from the initial structuring to overseeing ongoing operations.
We have a strong track record, dating back to 2002, of acting as an independent manager of publicly offered funds distributed in Japan. Indeed, our publicly offered schemes are distributed by well-known distributor companies throughout the country. The offshore fund platforms that we provide give investors access to a wide range of derivative products provided by investment banks.
The manager provides a skilled board of directors designed to take governance into consideration, as well as monitoring the other delegates in the offshore structure to ensure the fund’s investments are in compliance with the investment objectives. (The importance of good corporate governance is discussed in more depth in Manabu Nagano’s article on the merits of using an independent offshore fund service provider.)
Using an independent manager like Moore also provides the investors with protection against conflicts of interest involving the investment advisors or the investment banks. Or, to put it simply, it stops investment performance being the only driver.
At Moore we have invested in our computer systems and have a bespoke system that manages the operations of the structured funds. Our system will upload price feeds and applications for subscriptions/repurchases, allowing us to then calculate the available cash and place the relevant investment instructions. As well as investing the assets, we will also take care of the annual filings of the unit trust, determine distributions, approve expenses, engage the auditors and provide performance reports to the investors.
If you would like more information on Moore’s structured product services, please feel free to contact me.
T: +81 (0) 3 6441 0570