J.P. Morgan Private Bank is gearing up to become the latest firm to offer an insurance-like hedge fund product to its wealthy clients.
The product, an obscure but increasingly popular offering called an Insurance Dedicated Fund (IDF), enables investors to defer and in some cases avoid paying taxes on their investment gains.
Initially the New York bank’s wealth management group plans to offer IDFs with an investment portfolio managed by three different New York-based hedge fund firms: Third Point, York Capital Management, and Newbrook Capital Advisors.
The firms have not yet officially agreed to a deal, and there has not yet been full approval, according to a person with knowledge of the situation. Another source says that at this point it’s preliminary, since nothing has been agreed upon. Yet another source says he assumes a deal will get done “in real short order.”
The hope is to begin offering the products at the beginning of 2017. JPMorgan and the three hedge fund firms declined to comment.
IDFs have been around for more than ten years. There are at least 125 IDFs in existence, according to Frank Napolitani, a director in the financial services group at accounting firm EisnerAmper.
They are mostly marketed to wealthy individuals, family offices, and corporations. “They are another channel to raise capital from,” he explains.
There are basically two different products: private placement life insurance and private placement variable annuity. Both are underwritten by insurance companies.
Large insurance players structuring these products include Lombard International, Prudential and Zurich American Life Insurance Company.
A private placement life insurance policy, which is structured as a life insurance policy, requires a medical exam for the individual who is taking out the policy. This could take a few months to be completed. Once the investment is made, the premium goes toward investments, which are generally hedge funds but could be other types of investments, including private equity and real estate. Gains are tax deferred and policyholders can make withdrawals in the form of loans against the policy and pay it back at very low interest rates. The big potential kicker: A tax-free benefit for beneficiaries when the policyholder dies. It is considered a good estate-planning strategy.
A private placement variable annuity offers similar characteristics, except there is no medical exam required. It potentially can be put in place in a matter of weeks and invest in the same type of underlying funds as the private placement life insurance policy.
Bear in mind that a hedge fund connected to an IDF can’t be exactly the same product as the hedge fund firm’s other offerings. There must be some wrinkles that make it different, either from composition of investments, number of stocks in the portfolio, size of positions, or weightings. “It has to look different,” stresses an individual who is familiar with IDFs. “There has to be clear guidelines over how it operates.”
In the case of Third Point, York, and Newbrook, the investor is getting access to the firm’s team and general strategy. Third Point, led by Dan Loeb, and York, led by Jamie Dinan, are well-known hedge fund firms. Newbrook is lesser known. However, it has been included on J.P. Morgan’s hedge fund platform for more than a year. It is a long-short specialist founded in 2006 by Robert Boucai. Today it manages about $1.5 billion.
In the third quarter, its main hedge fund, Newbrook Capital Partners, returned 2.9 percent, leaving it slightly negative for the year. In 2015, it gained 13.6 percent, way outperforming the vast majority of long-short equity funds.
Although IDFs have become increasingly popular in recent years, experts think that if Hillary Clinton becomes president, growth will most likely accelerate, given her promise to raise taxes on the wealthy and to raise the estate tax.
