Selling and promoting structured products as an asset allocation solution as opposed to getting trapped in the particularities of the 'zero coupon bond plus an option' structure could help to overcome the current stagnation as well as making this segment of the market more appealing for US investors and move it forward, according to participants of the Investing in Alternative Assets panel discussion at SRP's sixth annual Americas Wealth Management & Derivatives conference in Boston on June 15.
On the question of how structured products fit within asset allocation models, Jason Baresma (pictured), co-founder & president, Halo Investing, pointed that after a long career in the private banking side he understands the challenges in the buy-side to explain customers were a structured product fits in a portfolio.
"The mistake of introducing these products as bond plus an equity-like kicker is that it gives the impression that it's a fixed income investment and most structured notes we deal with are not," said Baresma. "I prefer to introduce them as a way to manage some of the principal and market risk within a portfolio. You bucket that as you would the underlying so if I have a product with a barrier linked to the S&P 500 I would introduce it as US cap core and if I had a product with enhance yield on a basket of indices (Eurostoxx 50, S&P 500 and Russell 2000) I would introduce it as global equity."
However, according to Baresma, a number of registered independents advisers (RIAs) which made up to 50% of Halo's customer base, have never used a structured products before.
"That presents a good opportunity for the industry but also challenges around education," said Baresma. "One of the problems when talking about these products with advisers is that they don't know how they are going to price in the account. Advisers don't really care that you are offering a growth structure with leverage on the S&P 500 with downside protection because if the market goes down they will only see the drag in their portfolio."
According to Baresma, advisers don't care about the leverage of the product after three years but how is performing during the first year "and they will see it as underperforming the S&P 500".
"The biggest problem structured notes have in the US market is that most RIAs think of them as bonds and they see them as risky positions within a bond portfolio," said Baresma.
The best way of explaining how structured notes fit within an asset allocation model from a distributor perspective is from a top down approach, according to Ed Condon, national director client solutions at Merion Capital Group.
"Because we're selling to the independent channel we don't see this kind of issue that you can find in wire-houses where there is a mothership mentality and an actual asset allocation model," said Condon. "In the independent segment is the adviser trying to figure out how to respond to that question. As a distributor what we do is listen to them and understand that if they are a user of these products how do they make it fit into their clients' portfolios."
According to Condon, in cases where we are introducing an adviser to the product the pitch is not around the asset allocation but about what their clients want to achieve. "Is it yield? Partial or full principal protection?," said Condon. "Our approach is to see how the structured notes we want to talk about fit into those needs. Each individual adviser is figuring out how structured notes respond to their clients' needs by themselves and I think it is our role to listen and understand what solution would work for them."
According to Eric Miller, managing director, structured product sales at HSBC Bank USA, when the discussion is at an adviser level the focus is on how the product fits the risk profile of the end investor. "However, when you distribute to larger distribution channels with 10,000 plus advisers the one-size fits all used for some time did not work, and held the market back," said Miller. "Part of the growth we have seen over the last couple of years is down to the fact that structured notes are now being sold as a solution-based product."
Structured products are risk management products and they should not be presented as alternative investments, according to Miller. "One of the problems structured notes have is that they don't fit in the concept of actively portfolio management," said Miller. "Wilshere and Morningstar sell millions of dollars-worth of products through their portfolio models but structured products don't fit into those. Structured products need to be explained for what they are because if you get pigeon-holed into one of the components then it is one-size fits all and that's not what structured notes are about."
According to Miller, structured products should be presented as alternative risk management strategies on a traditional investment. "These are prudent necessary investment vehicle for managing risk on the traditional assets," said Miller.
Robert Sowinski, managing director, structured products solutions at Advisors Asset Management, and formerly at Citi and Jefferies said that he thought he knew what asset allocation was when he was in the sell-side. "When I moved to the buy-side, and after many talks with RIAs, I figured out that structured products are a very bespoke idea that has to fit the book of business of each individual RIA," said Sowinski. "What works for one adviser will not work for all advisers. In AAM we have 500 active RIAs and another leg of business covering over 35,000 independent broker-dealers and it's difficult to find an allocation model where structured products would fit."
However, according to Sowinski, AAM's approach is that with a certificate of deposit (CD) or a principal protected note, then asset allocation belongs as a portion of the fixed income portion of the portfolio; if it is risk to principal it is seen as a typical preferred stock; and if it's high leverage with a barrier it is seen as equity allocation.
"But we also present these trades as risk management tool," said Sowinski. "For a 10 year plus trade with worst off features and a steepen component it would be difficult to find an allocation other than the end investor will get a very high coupon with a tone of risk behind it. Maybe there is a fourth bucket alongside bond, equities, and alternatives which could be risk management but we see structured products fitting in portions of fixed income and equity allocations."
According to Baresma, principal protection is different to capital at risk, and this has to be taken into account when talking about asset allocation. "In the past people thought of structured products as bonds because the product offered a coupon and that's what caused problems in 2008," said Baresma. "If you have market and principal risk that's not a bond. At Halo what we are trying to do is to focus on technology and education to make structured products scalable because the one on one conversation will prevent the market form expanding."
Very often when you ask where a structured note appears in an adviser's statement, you have structured notes alongside corporate bonds which makes no sense, according to Miller.
"Some advisers don't have a yield or cash flow requirements at all," said Miller. "Those who had a yield or a high yield requirement they would buy high yield bonds or mutual funds but that approach is no longer working and that's why advisers are opening up to all sorts of alternative products such as MLPs, REITs, etc. For us the structured products business needs to be scalable."
Scalability can be achieved with technology, according to Baresma. "Portfolio management is changing because the two mandates coming from clients now can be reduced to 'get me 5-7% and don't lose any of my money'," said Baresma. "They don't care what asset allocation model you apply as long as you deliver what they want."
Structured products are an access solution for the retail market especially for those who don't have the financial acumen to go out there and trade options, according to Sowinski, adding that buffer-type of strategies are simple and easy to understand; and market-linked CDs (MLCDs) are also appealing to investors "because you can get good returns if the market performs and your capital is protected and you have the FDIC guarantee if things go South".
"We think these products can be seen as yield enhancing strategies within a fixed income portfolio," said Sowinski. "We see value in paring ETFs and addressing correlation via baskets and the autocall feature has also got increased traction over the last few years because you can deliver that 8-10% coupon within one year. RIA are also focusing more on leverage growth strategies via uncapped exposure to ETFs, stocks or indices."
According to Condon, unit investment trusts (UITs) are coming back but Merion does not see them as competitors of structured notes in the alternatives segment. "We have a UIT offering and we see them in a similar category to structured notes although there is no cross-over in terms of the end investor," said Condon. "Close-end bond funds could be seen as a competitor type of product (good returns, exchange listed) but they don't have a maturity date. I rarely lose a trade to an ETF and it's usually the other way around which suggests that advisers and end investors can see the value of a structured note."
The panel concluded that in order to continue expanding the market there has to be an emphasis on performance. According to Miller, a firm in the US (Raymond James) has done "a very good job in selling structures that have proven to deliver not only for the client but also for the adviser".
"They have been adding to the transparency of the market by publishing performance figures of products such as callable yield notes in relation to their underlying, and I think once you can prove to the end investor that a product delivers you can move in the conversation," said Miller. "I think performance will drive the success of the market."
The notional invested in these products perhaps isn't reflecting the market growth but there is an increasing number of advisers using these products "and that's also an indication of how structured products are perceived in the US market", according to Miller.
"This kind of development shows that despite the challenges the market is in the right track to continue growing."
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