In the second part of an interview following Cboe Vest's structured funds surpassing US$100m in assets under management, Karan Sood (pictured), chief executive at the company talks about the competitive environment in US, the challenges around distribution and how unit investment trusts (UITs) could open up opportunities in structured products as an alternative wrapper for retail investors.
"Our first ever structured unit investment trust (Suit) that uses Flex options (flexible exchange options) has been replicated by some newer firms that are entering that market," said Sood. "Distributors get more comfortable if there is more depth in the market. We are now seeing firms make filings on the mutual fund and ETF (exchange-traded fund) side that are very similar to ours. We take a long view of this opportunity."
One of the key aspects to consider is educating investors about the novel products and the unique risks they embody - Karan Sood
The company is not as competitive with bank equity derivatives desks as it may seem, because a typical investor in a mutual fund is not one that invests in structured notes, according to Sood. "Also, unlike banks, we don't inventory the risk that results from our products," said Sood. "On the other hand, we collaborate with banks to help with the execution of the derivatives and, as such, enjoy a symbiotic relationship with the equity derivative brokerage banks we work with."
The company has sought a "very robust dialogue with the customer base", and, as a result, is highly specialised in distribution, according to Sood. "We pay very close attention to what financial advisers want - and our interaction with the advisory side informs our product design," said Sood. "When we introduce new products, we make a very strong and concerted effort to educate our customers about the way these products work. We have an internal research team that publishes white papers which complement the educational resources offered by our index partners."
Independent advisers, including registered independent advisers, as well as mid-market brokerage and regional companies are the most receptive to the offering. "Such pockets of the marketplace have historically been underserviced from a structured note perspective or have been ruled out of investing in them due to the increased risks embedded in a debt wrapper," said Sood. "They view our offering as a novel solution to their investment problems or a more investor-friendly wrapper through which to access the payoffs they like."
The biggest opportunity "not only for us, but also for other firms", is to make these products accessible to those investors who have not looked at them before because of the constraints of the note wrapper, according to Sood. "That's a much bigger opportunity for the entire ecosystem," said Sood. "Structured notes make up a very small segment of investor portfolios in the US. At the end of the day, the risk that is embedded in these products is still being hedged by banks, so the supply dynamics with our products, or with structured notes, are quite similar. It's the demand side which is very different and is the key to take this from a $5 billion industry to $500 billion."
The payoffs used in the funds can be applied to different sets of underlying investments, including international equities, commodities and fixed income, according to Sood. "One of the key aspects to consider is educating investors about the novel products and the unique risks they embody," said Sood. "As we develop newer payoffs, we want to be mindful of the educational aspects and do not want to introduce undesirable complexities."
New products in the company's pipeline will be motivated by specific needs expressed by financial advisors. "We are seeing a strong demand for income from our client base," said Sood. "Traditionally, income needs are fulfilled by investing in fixed-income instruments. However, fixed-income yields are currently quite low and, with rates likely to increase, investors are looking for alternative solutions. Our income solutions monetise the volatility in the equity market, and as a result are resilient to rising rates."
Suits will co-exist with structured notes as the investment community continues to demand "novel solutions" to address the unusual market conditions, according to Sood. "Structured products, in whichever wrapper, are well suited to be solutions to their desire for unique investment products," said Sood. "Contrast that to the commoditisation of more conventional investments, which make it difficult for the financial adviser to demonstrate value to their customers.