ETNs offer effective wrapper for equity products with strong intellectual capital, Nuveen's Forst says

By Kenneth Lim

Boston, Aug. 11 - The exchange-traded notes market is ripe for more diversification into equity-based investment strategies, said Nuveen Investments' Michael Forstl on Monday.

Meanwhile in structured products, Lehman Brothers Holdings Inc. priced $600,000 of an unusually structured series of principal protected dual participation notes linked to the price of crude oil.

There has been healthy interest in recently launched Elements ETNs linked to Nuveen HydePark Group, LLC's new Benjamin Graham Intelligent Value indexes, said Forstl, Nuveen's managing director.

"We've been getting a lot of calls, a lot of calls from the press," Forstl said. "There's definitely some initial interest."

Deutsche Bank AG was the issuer of the new ETNs, with $750 million offered in the initial launch.

The first series of notes comprises $250 million of ETNs linked to the Benjamin Graham Large Cap Value Index - Total Return. The second series also consists of $250 million of ETNs linked to the Benjamin Graham Small Cap Value Index - Total Return. The final series is $250 million of ETNs linked to the Benjamin Graham Total Market Value Index - Total Return.

The indexes track U.S. stocks selected according to a methodology based on value investing pioneer Benjamin Graham's ideas. The indexes, which will be re-allocated semi-annually, will focus on businesses deemed to have strong, liquid balance sheets that trade at a discount to their implied intrinsic value. Nuveen HydePark Group, LLC, which will manage the indexes, created them on July 28.

At maturity or when put by the investor, each $10 par note will return the same percentage change as its relevant underlying index less an annual investor fee equal to 0.75%. Investors will gain and lose 1% of their investment, before fees, for every 1% increase and decrease in the index.

The Benjamin Graham Large Cap Value Elements will trade on NYSE Arca under the symbol "BVL." The Small Cap Value Elements will trade under the symbol "BSC" and the Total Market Value Elements will trade under "BVT."

Nuveen Investments and Merrill Lynch & Co., Inc. are the distributors.

Notes an alternative to funds

The notes can be seen as an alternative to traditional mutual funds or exchange-traded funds, Forstl said.

"If you look at ETNS and where you've seen the majority of interest and popularity on the structural applications, it's been in hard-to-reach asset classes like commodities," Forstl said. "What we're doing here is we're linking a note to an equity strategy."

Equity strategies that rely heavily on the expertise of a manager, whether it is an actual fund manager or an algorithm such as the Benjamin Graham indexes, are better suited for ETNs, he said.

"Until they've solved the problem of having to make available the ultimate portfolios on a daily basis [for funds]...ETNs are the best way to offer these strategies," Forstl said. "The underlying portfolio doesn't have to be made on a daily basis, it will be made available on a monthly basis."

Those equity strategies are an important and underserved segment of the investment pie, he added. There are currently just under about $600 million of ETNs on the market currently that were built on the open Elements platform, Forstl said. Most of the Elements are commodities-linked, but equity solutions could play a bigger role, he said.

"That's really the biggest part of the [overall] market," he said.

Product development took time

The Benjamin Graham indexes that underlie the new ETNs were a project that started long ago, Forstl said.

"This was, more years than months," he said. "It takes a while. We really spent a lot of time working with indices. We wouldn't be able to do this on our own, this really relies heavily on the intellectual capital at Nuveen HydePark," which Nuveen acquired about one and a half years ago.

Nuveen managed to contract out the use of Benjamin Graham's name for the products, and sought to capture the value investing pioneer's philosophy into an algorithm, Forstl said.

"If you boil down his philosophy to one term, one overarching tent, it was 'margin of safety,'" he said. "We've interpreted as much as we could of those initial teachings and put it into a contemporary format. But it's not a strict interpretation, because in today's marketplace we have tools and analytics that weren't available in the 1940s."

The indexes screen U.S. stocks based on their earnings quality, valuation, forward price-earnings ratio, dividend yield, profitability, liquidity and measurements relative to industry peers.

Forstl stressed that the indexes and the products linked to them carry a great deal of intellectual capital that make them different from other equity-based indexes.

"We're not competing with the bulk beta or SPDRs or some broad indexes here," he said.

Products fit value sleeve of portfolios

Forstl said the products will fill the "value sleeve" of portfolios.

"If you have a core and explore strategy, you can use Benjamin Graham as your core, and you couple that with a satellite high-yield manager in a mutual fund, you can decrease your cost for your value sleeve," he said.

The products also provide long-term consistency for alpha-seeking investors, he said.

"One of the problems that this solves for is style drift," he said, referring to the possibility that a fund manager's decisions could drift away from the original strategy over time. "This product is meant to stay within its values."

Helping investors and investment advisors understand how the products fit in a portfolio will be a key part of the marketing strategy, Forstl said.

"We are doing a major meeting here at Nuveen tomorrow for our wholesalers, close to 100 salespeople," he said.

Lehman prices oil-linked notes

Lehman Brothers priced $600,000 of zero-coupon 100% principal-protected dual participation notes due Aug. 22, 2011 linked to the price of crude oil.

The notes have an unusual payout feature that yields a positive return even if the price of oil breaks its thresholds. More typical dual participation barrier notes return only par if the range thresholds are exceeded.

In the case of the Lehman notes, if the price of crude oil stays within the range, payout at maturity will be par plus 150% of the absolute value of any change in the price of crude oil. If the price is not within the range, the payout will be par plus 40% of the absolute value of any crude oil price change. Investors will receive at least par.

The upper barrier for the range is $172.80, 150% of the initial price of $115.20. The lower barrier is $57.60, 50% of the initial price.

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