Wavecrest starts structureds-focused hedge fund; new firm aims to fill niche as investor advocate

By Kenneth Lim

Boston, Oct. 8 - There has never been a better time to use structured solutions, say industry veterans who have decided to place their money where their mouths are.

Former Morgan Stanley sellsiders Jeremy Berman and Justin Frankel have created Wavecrest Asset Management, an investment advisory firm and hedge fund manager that will focus solely on structured solutions.

"There's never been a more important time to analyze the trade-off between risk and return," Berman told Prospect News.

Berman, a former manager at Morgan Stanley's structured solutions group covering the eastern half of the United States, and Frankel, the former head of structured investments at Morgan Stanley, started Wavecrest in August. The New York-based firm already has a hedge fund, Wavecrest Partners Fund I, that has less than $10 million in assets under management, and will also offer separate account advisory and consultancy services.

Starting an asset management firm in the current market turbulence can be tough, a point that Berman acknowledges.

"Investors have a kind of an inverse psychology," he said. "When things are really good they want more of these, but when things are really bad they want less of it."

'Unbiased, independent view'

But the partners reckon that there's a hole to be filled in the marketplace.

"We set this up in response to what we saw in the industry as a dealer-dominated distribution model," Frankel said.

After years on the sell side, the two men said they realized that investors were not being fully served because the distributors who offered structured products were often tied to one or some of the issuers.

"Whether they are clients or investors, what we offer is an unbiased, independent view in choosing structured investments and increasing the probability of success in any type of investment," Frankel said.

"We see the explosive growth in the industry, and we see structured products gaining more mindshare and wallet share. And at the same time we've seen the explosive growth among independent advisors, and we want to have a chance to work with those advisors and fiduciaries without any of the potential conflicts of interest when you carry just one firm's name on your desk."

Wavecrest views itself as an investor's advocate in structured products.

"Think of us more as, our relationship with the different dealers is more as a client to them rather than another distribution channel," Frankel said. "We have our own investors and our own clients and we work with them...We'll go to the dealers for the actual pricing and execution of those ideas. We're not trying to take a dealer's calendar and on-sell it to our clients."

Going beyond one-off plays

Many of the investors and investment advisors are also using structured products as a one-off instrument, whereas a more systematic approach could yield better returns, Berman said.

"If you buy one structured product in one point in time, you're going to get one possible outcome, whereas if you use several products together you can smooth out some of that path dependency," he said.

Berman added that structured products work "very, very well especially in markets that are in single digits."

"Typically, structured investments are designed to trade away unlimited upside in return for enhanced upside or partial principal protection or full principal protection or enhanced income, even," he said.

"It's markets like these when it really shows its value. If you thought markets are going to go up 50%-60% you would use all your cash and buy equities, or if you thought markets are going to crash you would sell all your equity and keep the cash. It's in the middle ground where there are certainly efficiencies to be gained."

Exploiting those efficiencies is the goal of Wavecrest, which is "looking to increase the probability of success," Frankel said. The firm will not be using just structured notes; it will also use customized structured products, over-the-counter products, listed options and swaps. That strategy will give the firm the flexibility to pursue its investment goals and avoid certain potential pitfalls, such as counterparty risk, he added.

"If you were to do something in note form right now, and you were going to use one of the financials as your counterparty...given where they are right now you might not be comfortable with having them as a counterparty," Frankel said. "You may choose instead to carry out the trade in a different way...Being independent gives us better flexibility in choosing our counterparties and issuers."

Optimistic on industry

The current tremors in Wall Street are likely to lead to consolidation, and while that may reduce the number of players on the issuing side, the result should be better for the structured products industry, Berman said.

"There's certainly going to be consolidation among the issuers, and that's going to trickle down to the structured investment business," Berman said.

"Market participants will be leaving as they already have, as we've seen with Fannie Mae and Freddie Mac. And Merrill Lynch and Bank of America are now going to be the same...But we think the consolidated player is going to come out better...I don't think the consolidation is going to cause that much less competition. It's not like there were 50 before and there's going to be three now. There were 50 before and there's going to be 47."

Education also remains a key priority for Wavecrest and the industry, Frankel said.

"Jeremy and I have always believed in the necessity in educating the end client," he said. "It's important to the process that the client is aware of the risk and rewards of their investment. Whatever type of consolidation happens, we want to continue to be advocates and continue to be a source of education."

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