The Hedge Fund Report: Another Way to Bet With Pros

Want exposure to hedge funds without investing directly in one? Need access to the alternative asset class while at the same time preserving capital? The answer may be a structured product, a semi-exotic investment instrument in which a derivative facilitates exposure to a basket of funds or an index.

In some cases, the instrument is a financial contract. In others, it is a note. In Europe, where structured products are perceived as a good way for retail investors to access alternative investments, these vehicles have become very popular. They are starting to get attention in the U.S., although for different reasons.

Part of the appeal of structured products is that they can offer protection against downside risk. For instance, with a structured note, the investor recoups his principal at maturity, plus hedge funds returns, if any. Because these instruments are hard to design, however, the guarantee often comes at a cost. To counter that, banks that structure those derivatives often use leverage or options to enhance returns.

It looks complicated and risky, but in reality, these products are merely expensive and conservative. For the risk-adverse investor, structured products may be a viable alternative to investing directly in hedge funds.

There are several ways to gain access. Two emerged last week.

The first one came from hedge fund manager HFR Asset Management, which announced a new partnership with J.P. Morgan(JPM - Cramer's Take - Stockpickr) to offer structured products pegged to HFR's platform of managed accounts. HFR is similar to a fund of funds, but the platform is structured in a trust format. Instead of investing in hedge funds, the investors have separate accounts with each manager. Assets remain under the custody of the trust, which gives investors much more liquidity and transparency than if they had invested in a traditional fund of funds. Through the partnership, J.P. Morgan will help its clients choose a basket of managers from the managed account platform, and the bank will issue structured products linked to the selected basket. The investor will buy into the basket indirectly via a structured product. This approach is considered to be active management, as the client designs his own portfolio.