Cboe Vest's structured product-like set of mutual fund products, including its S&P 500 Enhanced Growth Strategy Fund, S&P 500 Buffer Protect Strategy Fund and S&P 500 Buffer Protect Index Balanced Series which were launched earlier in the year have crossed $100m in assets. Three of the funds are very similar to structured notes and replicate popular payoffs in the structured notes market. "The early growth - from their launch to more than $125m in assets across such strategies - is an encouraging indication of the demand for such payoffs from investors," said Karan Sood, managing director at Cboe Vest. "To be able to offer these kinds of payoffs in a 1940-act compliant delivery vehicle is something that has not been done before."

Cboe Vest has been the pioneer, starting with its 2013 filing of a Structured Unit Investment Trust (Suit) that contemplated using listed flex options to replicate a structured note payoff. The filing has since spawned similar structures from competitors including Olden Lane Securities, which launched a distribution partnership with Axio Financial in November to distribute target outcome funds range to independent broker dealers, wirehouses and registered investment adviser channels in the US; JVB Financial Group, which entered the market earlier this year; and Alaia Capital's, which launched its Market-Linked Trust platform, in February 2017, and entered into a distribution agreement with Incapital in October.

The company will continue offering customised versions of such strategies as managed accounts, according to Sood. "However, the firm has had most success with the mutual fund wrapper as it offers a delivery mechanism that most investors are familiar with," said Sood. "More specifically, the wrapper offers operational and governance attributes that investors have come to expect from and depend on in investment products - daily liquidity at an independently calculated net asset value, governance structure that meets the conditions of fiduciary accounts, a regulatory imposed diversification of credit risks and an optimal tax structure. All of this means that it is likely that to most investors, a mutual fund regulatory structure is a more familiar and hence preferred choice to other investment structures such as notes."

This is borne out by the overwhelmingly large number of financial advisors who are buying Cboe Vest mutual funds for their clients do not generally invest in structured notes, according to Sood. "Despite the high utility for such payoffs in investor's portfolios, structured notes make up less than 1-2% of investor portfolios," said Sood. "We are hopeful that with the same payoffs now available in a wrapper that's likely to fit in well with the expectations of most investors, there will be larger uptake. From an overall perspective, development of payoffs in mutual funds, UITs and ETFs is the key to taking the US market, which lags significantly behind Europe, to a new level."

Despite their appeal in investment portfolios, there are systemic hurdles to wider adoption of structured notes, according to Sood. "There is limited availability of notes due to restrictions from custodial broker-dealers. Depending on the interpretation of regulations, they may not meet fiduciary standards and as a result may not be suitable in retirement accounts," said Sood. "They are classified as illiquid, as there is not a contractual or regulatory requirement to have a secondary market at a price that is competitively discovered or independently calculated."

Advisors seek to limit concentrated credit risk in client portfolios and not be concerned about the conflicts of interest of a bank treasury funding vehicle being positioned as an equity linked investment, according to Sood. "Such aspects can stop the conversation with a potential investor, even before reaching the stage of understanding the merits of the investment, and as a result, limit the market size," said Sood. "Mutual funds strike a daily net asset value, have daily liquidity, and the governance structures of registered products without concentrated credit risk. Then the conversation gets to the next level, where the investors examine the payoff and assess it based on their views of the market."

Sood also points that another "ancillary aspect" of structured note offerings is that they are payoff oriented and hence more of a tactical allocation to investment portfolios. "In contrast, when offered in a mutual fund wrapper, the rolling nature of the payoffs makes investors view the investment more strategically," says Sood. "They don't look at it purely as a payoff, but as a strategic allocation that is geared towards growth, protection, capital preservation, or income."

[1] Source: Bloomberg, Structuredretailproducts.com

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