Maybe an elementary question for this forum, but some fund of hedge funds are offering principal protection for 5-10 years on their funds.My question is: How can they be offering principal protection and simulatenously have the funds to invest it where they'd like to? Are they borrowing money first, then entering into some sort of transaction with their lender?Thanks folks.

tmoi,I assume you are talking about CPPI. The fund of funds manager runs a managed account where he takes 100% from the investors from start and holds the eqvivalent amount of a zero coupon with maturity at the same time as the proctection ends. The rest of the cash will be invested directly in hedge funds. You normally attach a gearing of about 4. The higher the gearing the sooner you have to liquidate in case the performance falls. The floor (always to be maintained) will rise along with the value of the benchmark zero coupon.I don't know what happens if the fund continues after the protection ends.Below is a link to a good and very non-quant text about this subject:www.securitization.net/pdf/Hedge_Fund_051203.pdfYou can also run a search for CPPI on this website.Please correct me if I am wrong.Regards,Ola

Thanks for your reply. The CPPI was what I was looking for and that's a very good paper.

Hi OlaThis is Mathieu I didn't know the articletmoi, just to clarify, you have 2 types of techniques to provide capital protection on Fund of Hedge FundEither you structure a ZC , that insure the protection at maturity + a call on the Hedge FundOr you structure a CPPI, which technique is well describe in the articleMathieu

Mathieu,Nice to hear from you.In deed, these two methods are each championed by SG and BNP Paribas, two of the top equity derivative houses in the world.See below for a free (!!!!!!) article in Risk mag.http://db.riskwaters.com/public/showPage.html?page=1837

BNP preferes the option based strategy and SG preferes CPPI, however both are way to expensive compared to the street now adays.some of the newer advances in cap gteed structures include VPPI (v= variable and can be linked to vol or buffer) and option on CPPI structures.

Donyoshi,Do you have a link to site for these products or even a term sheets to upload?Which banks structure such deals?Regards,Ola

not allowed to upload termsheets. The termsheet for an option based cppi deal look like a zcn + call termsheet, where the underlying asset is a cppi portfolio, defined as an annex to the termsheet. since the hedge of this portfolio is the delta on the theoritcal value of the cppi portfolio (instead of the cppi itself), the advantage is that one is more flexible, for example one can include a minimum exposure > 0% or have a higher initial allocation with out changing the gearing factor. As the hedge is the delta of the cppi detla, the product has similarities to a compound option.The banks doing such deals are Barclays, GS, CDC, DB, and I'm pretty sure SG and BNP can price them too.We (Bank Julius Baer) can price option based cppi deals, however we don't trade them, as our books aren't large enough (yet), so we stick to the plain vanilla stuff like cppi.

State of the market : CSFB is according to the head of fund derivatives structuring at BEAR the biggest house on Fund derivatives. 80 people on the floor.LEH , BEAR, BNP and SG are goodCommerz, Nordea, Rabo, IXIS are good competitors... According to MTN-i, biggest 3rd party dealer of Fund derivatives deal (through EMTN is Commerz).... About FoHF who offer Pricinpal Protected Notes or Constant Leverage Options embbeded in share classes with 2,3 or 4 times for the leverage like Gottex, Man are all doing that thru investment bank (believe me it s juicy business).the Investment bank invest in the FoHF which serves as the underlying to hedge its position.Some good houses like BEAR and LEH are even offer options on Hedge Funds directly thanks to their excellent Prime BRokerage business