Deutsche links to cross-asset alpha index; risky but alternative to hedge funds, adviser says

By Kenneth Lim

Boston, May 5 - Deutsche Bank AG's planned index-tracking notes linked to a proprietary alpha index offers an alternative to investing in hedge funds, an investment adviser said.

Deutsche Bank plans to price zero-coupon Market Contribution securities due May 31, 2013 linked to the Deutsche Bank Liquid Alpha USD 5 Total Return index.

The index comprises alpha indexes in five asset classes - equity, commodity, foreign exchange, interest rates and cash. The constituent indexes are the S&P X-Alpha USD Total Return Strategy, the Deutsche Bank Commodity Harvest USD Total Return, the Deutsche Bank Balanced Currency Harvest (USD-Funded), the Deutsche Bank SMART USD and the Fed Funds Total Return indexes.

The weighting of each constituent index is determined through a computer-based model that would have generated the highest level of annualized return for the index at a predetermined volatility for the previous 60 business days.

At maturity, the notes will receive par plus the index return, less 0.75% and an annual fee of 0.75%.

The notes may be called at any time, and may be put on May 27, 2010; May 27, 2011; and May 29, 2012. The payout at early redemption will be calculated in the same way as at maturity.

Hedge fund alternative

Given the focus on alpha strategies, which aim to outperform benchmarks, the product could be an alternative investment to a fund, the adviser said.

"Usually when we talk about alpha we're looking at the value that a fund manager brings to a fund by the manager's ability to outperform the market," the adviser said. "It's not a new strategy, but Deutsche is clearly trying to replicate some of what the fund managers do by developing algorithms."

The key selling point to investors will likely be the cost of investing through the structured products, the adviser said. Hedge funds, in particular, are "easy targets" because they are often out of reach of retail investors. Hedge fund fees are also extremely high.

"If you go with a hedge fund, you pay 2% plus 20%," the adviser said. "With this one you're paying 0.75% plus 0.75% a year, and I guess each index has a bit of a fee worked into it as well, but in any case, you're still way below what a hedge fund typically charges. I don't think that many hedge funds did that well anyway, so you may really be better off with something like this."

Transparency could also be an advantage for the structured product, because the index's rules have to be fully disclosed.

"Everything is in the open," the adviser said. "You're less likely to be investing with a Bernie Madoff."

Risk takers only

But the adviser cautioned that the structured product is still highly risky. Investors may not be giving money to a fund manager, but they are still putting money in the hands of someone else. The risk of an issuer default should therefore be a consideration.

The structured product also has no downside protection.

"I guess if you're thinking of investing in a hedge fund, in terms of your downside exposure, this isn't worse," the manager said. "But just risk-wise, if you're a retail investor and this is for your retirement, you really have to ask yourself if you're ready to risk all your investment."

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