Based on emails that hit my inbox, structured products (commonly structured notes), have grown in popularity. In 2018, a study by Greenwich Associates found that sales of such products reached nearly $50B in the US and represent nearly 6% of all financial assets in financially savvy European countries like Germany and Switzerland. So, chances are good that a few of you reading this have or will soon consider structured notes. A little light googling will dig up some nasty things about these products….as well as some more glamourous portrayals. Like most things, each contain a portion of the truth and can be good or bad depending on the individual circumstances in play.
Without diving too deeply into the ins and outs (again, google will easily point you to the basic understanding), I’d like to paint the broader context and also explain why our firm has found good use for carefully designed notes in recent months. Briefly though, a structured note may be a fancy term but is simply a bond that is issued by a bank; but instead of a fixed rate of interest and a fixed payment at maturity – the interest and maturity amounts are contingent on market outcomes. These conditional outcomes are made possible by unlocking the power of options and providing investors a nonlinear investment experience. Linear merely means that your investment results will mirror the overall market: market goes up by 10, you’ll go up by 10; market goes down by 10, you’ll go down by 10. Options make nonlinear returns possible, where a market being down 20 doesn’t mean you’ll be down 20 (same to the upside). Structured products wrap these option solutions into a nice convenient and easy to understand package.
Structured product offerings hitting our email inbox are nothing new, it’s just accelerated in recent years. One reason why is a good one as it reflects the fact that the financial industry has been shifting towards the independent based advisor vs. the traditional brokerage house sales model. (Disclosure: I am biased as such an independent fee-based advisor). Stock and investment brokers have their place with a well-informed clientele that need their services of delivering products for a commission. But, the problem with structured products in a sales setting is twofold. First, these products only make sense when considered within an overall financial picture. In a sales setting, the broker is not necessarily considering the entire picture, they are delivering a product to you which YOU have presumably analyzed within your overall financial picture. The second problem is that the products being sold are often issued by the very banks or institutions these brokers are licensed to represent.
Recent innovation has democratized this industry and adapted to better suit a world dominated by independent advisors – where the client’s overall picture is considered, and no commission is involved to interfere with sales motivation. I.E. an advisor is paid along the way for managing of assets whether those assets are in stocks, bonds, or structured products. The innovation specifically is technology that connects advisors and their client(s) to networks of banks that can bid on notes custom designed by the advisor for their client (s). Specifically, for FEG this innovation has been made possible through Halo Investing, Inc, but I must stop short of discussing any specific amounts or formulas embedded in our note designs.
The appeal to us at FEG lately isn’t based on rocket science nor is that much different from what has driven their broad appeal over the last decade or so. Interest rates on bonds have plummeted and made it likely the total return from that part of the portfolio will be minimal for quite some time. But that doesn’t mean we can just gun sling by exchanging less stability for higher returns in the stock market. Stability, at the expense of lower returns, has a role regardless of how low interest rates are. But when designed correctly, a structured note can be a nice complement to the core combination highlighting the stability of bonds and total return appeal of stocks. Low interest rates have pulled down expectation for bonds everywhere. But I would never argue that bonds have no place. They still have a role that structured notes can’t play in terms of pure preservation. To varying, but often large degrees, we must accept that the stability we absolutely need will just come with no return. However, we are at a time when some creativity can go a long way to ever so slightly improve upon those results.
