BNP Paribas' derivatives group is testing the waters to see if small- to mid-sized pension funds would be interested in a principal-protected note. Excess returns would be generated by investing in hedge funds, equity and cash, and the asset allocation would be altered tactically. "The idea is to stay invested in the asset class that is doing the most out performance," said Kurt Overley, head of derivatives marketing. "This is another way for pensions that are not too familiar with alternatives to try and outperform benchmarks, and protect the downside." The note would aim to beat a benchmark, probably the Standard & Poor's 500 Index, by 2-3%. It would have a five- to 12-year duration. As well as pension funds, BNP is talking to funds of funds that have a large client base of pension plans.

This strategy is common in Europe and Asia, especially Japan, because investors there are less aggressive than in the U.S., and they have a stronger focus on downside risk, Overley said. It is too early to know when this strategy could be launched, he added.