Lehman Brothers ComBATS commodity-linked notes look reasonable but complex, advisor says

By Kenneth Lim

Boston, May 12 - Lehman Brothers Holdings Inc.'s newly launched ComBATS I strategy commodity-related notes appears pegged to a sound strategy, but the product may not be suitable for investors new to the sector, an investment advisor said.

"There are just too many different parts to keep track of, so I don't know if I'll recommend it to someone who's new to commodities," the advisor said. "It's like selling a magic box that could keep getting bigger, but you don't really know how it does it."

Lehman offers ComBATS notes

Lehman plans to price zero-coupon 100% principal protected four-year notes linked to the Lehman Brothers Commodity Based Alpha Trading Strategies I (ComBATS I).

ComBATS I is designed to be a monthly resetting market neutral alpha strategy that reflects the difference between the monthly returns on a basket consisting of a long position in the Lehman Brothers

Commodity index Pure Beta Excess Returns of 10 single-commodity subindexes and a short position in the Lehman Brothers Commodity index Excess Return single commodity sub-indexes for the same 10 commodities.

The Pure Beta index is itself a rules-based index that seeks to mitigate distortions in the commodity markets associated with investment flows and supply disruptions as well as potentially negative yield when commodity futures contracts are rolled over.

The payout of the notes at maturity will be par plus 150% of the strategy performance, subject to a floor of par.

Strategy appears sound

The ComBATS I strategy appears to be a reasonable way to hedge against declines in the commodity market, the advisor said.

"Based on just a quick reading, it looks like what they're doing is giving you 1.5 times however much their Beta strategy outperforms the basic index," the advisor said. "Basically you have an outperformance strategy. The good thing is that even if the commodity markets don't do well and both the Beta strategy and the basic index don't do well, you would still make a profit."

The strategy looks to have turned in a good performance historically, the advisor noted.

"Well, it looks like on the whole the strategy has gone up over the last seven years," the advisor said. "This is a four-year note, and any four-year period in that time has finished higher. Of course, we don't want to be caught just blindly depending on historicals, but this would suggest that there's something that works in this strategy."

The key to understanding the strategy is to comprehend the rules behind the Beta index, the advisor said.

"The basic index is pretty straightforward," the advisor said. "I think what you'd want to know is what the rule are for this Beta strategy and what its correlation is to the basic index."

Underlying seems complex

But understanding the Beta index could be beyond many investors, the advisor said.

"I haven't had time to really look at this Beta strategy, but I don't think I'd have the time and the energy to want to completely understand it if I didn't already get it," the advisor said. "There are a lot of parts here, and I just think it's too much work to try to understand it all."

The product does not appear to be designed for novice investors or those who are new to commodities, the advisor said.

"They always say that structured products provide access to new markets for investors," the advisor said. "But I don't think if I had a client come to me and say, 'I'd like to put some money in commodities," that I'd recommend this to them. I don't even understand it 100% myself, even though I'm sure it's a solid strategy. I'm sure it's an innovative product, but maybe it's too innovative for some people."

"I think if you were already familiar with commodities and you wanted to maybe get a leveraged exposure to this particular strategy, this might work for you," the advisor said. "Maybe you can get a different tax treatment by doing it this way."

Offerings slow on Monday

The launching of structured products slowed considerable on Monday, with only a trickle of prospectuses published through the Securities and Exchange Commission.

A distributor said there was nothing significant holding issuers back, but suggested that a lack of office time may be behind the change.

"I don't think there's anything going on," the distributor said. "There were a lot of deals last week. Maybe it was because there was a conference last week on Thursday and Friday, a lot of people were there."

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