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Structured Products on the Rise, Again

Following SIMON’s recent Goldman Sachs spinoff, advisors should expect to see more in the way of complex-structured products.

Stocks and bonds might not be enough to meet client expectations of their portfolios right now. That’s the worry that’s on the minds of advisors—and it’s leaving room for designers and distributors of complex financial products to strike while the iron is hot.

Structured products, alternative investments and private placements are gaining traction today in a way they weren’t even a few years ago. The Wall Street Journal reports $55 billion dollars worth of structured products were sold in 2017 in the U.S. Goldman Sachs recently spun off SIMON Markets LLC, “an online distribution platform for financial professionals focused on structured investments,” with the newly independent company citing investments from Barclays, Wells Fargo, J.P. Morgan, HSBC, and others. Meanwhile, Bank of America is backing SIMON’s competition, Luma Financial Technologies, and recently sold its investment feeder funds operations to alternative investing platform iCapital Network, which is busy building its own channels to give advisors access to alternative investments, like private equity. Advisors are hearing alts suggestions at conferences, like those made by Anthony Scaramucci at a Riskalyze event earlier this year, tucked amid references to the White House and a walk down Wall Street memory lane.

It’s not just the technology undergirding distribution or the marketing departments of product designers and sellers that are bringing complex products back in vogue. The nosebleed valuations some private companies have received after funding rounds even has legislators interested in updating the definition of “accredited investors,” potentially broadening the pool of investors with access to complex investments.

Market conditions are the prime factor leading to chatter about complex investing products, according to Scott Welch, chief investment officer at Dynasty Financial. With talk of being late in the credit cycle and the market standing on achingly tired legs, the stocks and bonds that provided good returns for client portfolios over nearly the past decade are not getting the job done these days. “People are beginning to question whether that’s enough right now, given where we are in terms of the economic and market cycles,” he said, describing some advisors’ attitudes toward publicly traded stocks and bonds. As of late, advisors have been looking at private market exposure, alternative investments, like hedge funds, and structured products, he confirmed.

Back in 2007, structured products were also hot. “The general trend is that structured products are moving towards the retail market,” said Keith Styrcula, 11 years ago. He was the founder of the Structure Products Association, an industry trade group. That year, $114 billion in structured products were issued in the United States.

Technology has made it easier to engage in price discovery, experiment with the product design of structured products, and in buying the notes, Welch added. Dynasty uses a platform called Halo to access those types of products, but it has explored using SIMON. Luma, backed by Bank of America and Morgan Stanley, is a competitor to SIMON, which in turn distributes its products through broker networks at Raymond James Financial and LPL Financial.

“The adoption of technology to help non-institutional, or high-net-worth advisors and clients, get access to complex products is an important trend taking place at the wirehouses and in the independent space,” said Lawrence Calcano, CEO at iCapital. “If you think about it chronologically, going back 15 years people bought stocks and bonds by calling brokers and they got prices sometimes in newspapers. Wave one was the adoption of technology to make what they were already doing easier and more efficient.”

As investors began accessing information and making trades online, their needs became more complex, argued Calcano. More complex needs necessitated more complex products.

“Wave two is the use of technology to facilitate an even broader investment product set for investors who have historically not had access to these products,” he concluded.

It’s not just advisors and product designers who are eager to profit. Even direct-to-consumer tech products are being marketed as hedge fund-esque. Wealthfront, for example, drew the ire of its users with the Risk Parity product it released in early 2018. Later in the year, Y Combinator graduate Titan opened to the public with a service that scans the holdings of hedge funds, looking for companies to invest in and providing downside protection against market drops.

Another factor in the rise of complex products is better-educated advisors and investors, according to advocates. Both SIMON and iCapital emphasize the educational components of their platforms and the work they’re doing to make sure advisors understand the products they’re using.

SIMON has 60 modules spanning two hours of educational content, each segment averaging about 120 seconds, said CEO Jason Broder, “We’ve invested a lot in education.” The firm, which plans to bring insurance products to its platform by the beginning of Q2 2019, said its educational materials “go into the weeds” about topics like product risks and is revisited frequently.

No Shortage of Naysayers

Not everyone agrees this is the best approach to introducing such complex products, however. A broadly educated financial system is more stable, because there’s a better chance all the pieces are functioning properly, Calcano said. “If you don’t understand what you’re doing, you shouldn’t be making the investments,” he said. “The more people investing in products they don’t understand, the more risk you have.”

But technology, education and market cycles don’t inevitably lead to the need for complex investments. Welch is skeptical of the argument that better-educated advisors and investors will seek out structured products, alts, and the like. “I don’t know how you’d verify someone’s education,” he said, noting that while advisors could get a particular certification or designation, there’s still an element of arbitrariness. “I think that’s more marketing.”

Others are even more critical, saying salesmanship is the true reason for the renewed interest in these types of complex products. “Structured products have never been bought. They’ve always been sold,” said Andrew Stoltmann, a Chicago-based securities attorney and past president of the Public Investors Arbitration Bar Association. “The technology argument is a canard used by those who are peddling these products,” he added. “Given the outsized commissions and fees that can be earned on these products, that is the tail truly wagging the dog.”

In the past five years, Stoltmann estimated he’d worked on around 250 cases involving alternative products. Brokers weren’t adequately educated on how the products worked and were relying on their firms to do the due diligence needed, he said. He wasn’t holding out hope that more education would address the risks present in complex products. “I don't think the brokers have the intellectual curiosity or the financial sophistication to assess these products and analyze whether they make sense for customers,” he said.

Many agree that platforms like SIMON are making it more convenient than it was in the past to shop for and compare complex products. That’s by design. For example, SIMON said its post-trade servicing and the ability to holistically look at risk management solutions on one platform are significant advantages. It’s the legacy of Goldman Sachs baked into a startup, said Broder.

But there are alternatives. Twenty-First Securities Corporation, for example, works with advisors who are interested in creating their own quasi-structured notes, said Robert Gordon, founder of the company. “Most of the time” the returns of structured notes can be replicated with ETFs and options, reducing some of the credit and liquidity risk associated with structured notes, he said. They’re also cheaper, said Gordon.

But they’re not as scalable as platform offerings and are more challenging for advisors to maintain, said Broder.

The recent rise of complex product platforms could also just be plain old expediency—at least that’s Stoltmann’s argument. With firms eager to bring in more fees and the current political environment ripe for deregulation, advisors should get used to seeing complexity. “They’re twin forces,” he said. “Lightning’s been caught in a bottle.”

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