Andrew Scherr on the Agony and Ecstasy of Structured Products (Euromoney)

by Andrew Scherr
Special to Euromoney Publications
with the Structured Products Association

“Financial weapons of mass destruction ” in the eyes of Warren Buffett, feared by government regulators, banned from the general public, and lampooned by politicians, academics and media, Structured Products are a market under assault. Even the name, “Structured Products” connotes something unnatural concocted in Dr. Frankenstein’s laboratory. Academics and populists have lined up pointing at fees, disclosures, return characteristics, and relative performance. Structured Products are held responsible for market dislocations, bank failings and all forms of economic turmoil including the current credit crises.

This fear and finger pointing is a natural response to the sweeping growth of the sometimes complex products that regulators, the media and some academics may not fully understand. When we see major hedge funds, banks and other participants disappear or become impaired overnight, it is enough to give even the most seasoned market participant pause and any segment of the market we do not fully understand becomes suspect.

And the U.S. Structured Product market has certainly blossomed. While already fundamental to European Investing, Structured Products have stormed Asia and are just taking a foothold in the U.S. where the market has been growing consistently at 60 to 80% per annum. Structured Products became deeply rooted in Europe during Unification as retail investors sought yield enhancement to counter falling bank interest rates. Next came Asia, as institutions sought principal protection on new asset classes. Canada and Latin America quickly followed. The U.S. however has been the slowest to adopt Structured Products in much the same way as it was late on the adoption of wireless telephony. With a well established infrastructure in place, it seemed less urgent to adopt the newest technology.

Furthermore, for Americans, Structured Products do not seem to make sense in the context of modern portfolio theory. To the extent that portfolios are allocated across markets based on their beta exposures, there is little room or understanding for an alpha exposure. After all, alpha is a zero sum game – or at least that is what the academics have said – and every positive alpha is offset by a negative alpha elsewhere. This is where the pendulum of active versus passive portfolios has again swung. Simply put, if you know a particular investment will pay off then go invest – otherwise, diversify.

And yet, despite all of the foregoing . . . the U.S. Structured Products industry is . . . well, exploding.

(Full article can be found on the StructuredProducts.org website by clicking here.)

Some RIAs See Structured Products as Key Strategy (Investment News)

Embracing strategies based on derivatives
Some advisers turn to structured products for risk management

By Jeff Benjamin
Investment News, April 21, 2008

A small but growing number of advisers are turning to derivatives-based strategies to help manage increased levels of market risk.

The structured-products industry, which experienced a 78% increase in sales last year to a record $114 billion, is uniquely poised for a growth surge, according to industry observers.

In the most general sense, structured products, which are created and backed by investment banks, involve the use of derivatives to meet specific investment objectives. Primary distinctions between structured products and mutual funds or exchange traded funds include a defined maturity date, a principal-protection option and the ability to be customized to a specific investor's view of the market.

The idea behind the strategy is to protect portfolios from a declining market.

"We're taking risk off the table by replacing equity exposure with principal protection and buffered notes" that are designed to limit downside risk, said Frederick Wright, chief investment officer at Smith & Howard Wealth Management LLC in Atlanta.

Mr. Wright, whose firm oversees $250 million in assets, was first introduced to structured products in 1999 but didn't get seriously involved until last year.

"It's a great risk-management tool, and it's an opportunity to be out on the leading edge as an adviser," he said.

Some advisers remain skeptical about the use of structured products as a risk-management tool.

For the full article in Investment News, click here.

SPA-2008 Day 2: Future Challenges, Opportunities (Prospect News Special Coverage)

By Aaron Hochman-Zimmerman
Prospect News Special Coverage

Structured Products Association Annual Conference 2008
For full coverage of SPA-2008 from Prospect News:
Click here for Day One (Wednesday, April 9, 2008)
Click here for Day Two (Thursday, April 10, 2008)

New York, April 10 – Moving into 2008 structured products issuers and dealers will have to ensure that clients are kept informed of what structured products can offer as well as deal with attacks from competitors, a panel said at the second day of the Structured Products Association summit.

Externally, the sector has come under fire by proponents of mutual funds who have put up a "very aggressive lobbying position" against exchange-traded notes (ETNs), which are not required to distribute income annually, said Adrienne Browning of Deutsche Bank.

Mutual funds are required to distribute earnings annually and are taxed accordingly. "In Congress right now, the fight is going on," said Ray Shirazi of Cadwalader, Wickersham & Taft LLP.

The Internal Revenue Service and the Treasury Department are currently accepting comments on ETNs and pre-paid forward contracts, Browning said.

Meanwhile, Rep. Richard Neal, D-Mass., who is "in the mutual fund district," according to Browning, has already introduced and is pushing HR 4912, which would require all ETNs to be taxed similarly to a mutual fund. "So that’s a big heads-up," Browning added.

‘Innumerable combinations’

Structured products must also contend with a supply chain that is unaware of the possibilities the products may offer or the pace of the new issue market. "Structured products really has arrived … Structured products has beaten closed-end funds in terms of size and issuance," said Eric Miller of HSBC.

"Investors do have a very good reason to look into structured products," he said, whether they want safety in terms of protection or FDIC insurance.

"As the baby boom generation ages, they will become more beta-phobic," said William Bamber of Bear Stearns, and a structured product could be engineered to suit that specific need.

"There’s almost innumerable combinations and permutations that we can dream up," he said.

Still, "education is what we all need to focus on before we can move to the next step," said Alexandre Ecot of Societe Generale.

Investors are becoming more sophisticated, Miller said.

Recently, "for the first time someone asked me what the CDS [credit default swap] is" for a structured product issuer, he said.

Many feel that "the Street has a better idea than the rating agencies" of an issuer’s credit, he said.

Favoring the simple

The panelists agreed that education is important, but creating products that are simple and transparent is important as well, said Stephanie Bosio of Calyon Securities. "Simple is beautiful," she said. Investors "tend to go for products that are all-in-one."

Success depends on innovation from issuer to wholesalers, brokers and investment manager, "the way it is in Europe and Asia. I actually believe there is not enough competition," she said, as it fosters innovation in a market that is far from saturated. "It all depends on us to make this U.S. market a big one," she added.

SPA president Keith Styrcula described the current credit crunch as a watershed event which may force investors to look away from traditional securities to more adaptive and flexible instruments going forward.

"We really have not come close to tapping the investor pool in this sort of market," HSBC’s Miller said.

SPA-2008 LeadingEdge Award Winners (Prospect News Special Coverage)

Improve education, standardize nomenclature, say investment advisors as issuer risks gain prominence

STRUCTURED PRODUCTS ASSOCIATION 2008 CONFERENCE
By Kenneth Lim
Prospect News, April 9, 2008

Issuers need to improve education resources, standardize nomenclature and address concerns about credit risk, a panel of investment advisors said at the fourth annual Structured Products Association Conference in New York on Wednesday, April 9.

Steve Braverman of MyCFO Harris Bank, Frederick Wright of Smith & Howard Wealth management, Tom Balcom of Financial Planning Association, Tony Proctor of Proctor Financial and J. Scott Miller of Blue Bell Private Wealth Management spoke to conference attendees shortly after winning in the first SPA LeadingEdge Advisors Awards.

Echoing sentiments mentioned by several other speakers at the conference, the advisors mentioned education as a key priority for issuers in reaching out to the advisor community. Many advisors remain unaware of structured products, the panelists said.

Many investors are also unfamiliar with structured products. For example, a common misconception is that a structured product is a win-lose battle between buyer and issuer, where a buyer’s loss is an issuer’s gain, Wright and Proctor said.

“I think there’s a need to address that skewed perspective,” said Proctor, who quipped that less education would actually keep his competitors away, on the sidelines of the conference. “The issuer is not taking a position . . . it’s not like in Vegas, where the house always wins. They [issuers] need to explain that we are simply providing a transaction.”

But getting issuers involved in education can be tricky, Miller said.

“Most of the education is done by someone who has something to sell,” he said. “And RIAs [registered investment advisors] are a special group of people, they all think they are smarter than everyone else.”

‘Too cute by half’

One way to ease the learning process is to standardize and simplify nomenclature. “Keep it simple,” Balcom said.

“Some of these are too cute by half,” Proctor said of the product names. “We are coming up with all these acronyms.”

Proctor added later: “One firm may call the buffered securities BUYS, another may call it something completely different. It makes our jobs so much more difficult…It’s not like just because you call it BUYS investors are going to want to buy it.”

The panelists nevertheless praised issuers for stepping up education efforts and helping to raise awareness of structured products.

“Now when I tell people about structured products, people are not saying that I have three heads,” he said.

Marketing material improves

Proctor also noted the growth in more-accessible marketing material.

“I think the issuers are creating client-friendly brochures more than they used to,” he told Prospect News.

Bear raises credit concerns

Issuer risk has reemerged as a key concern especially after Bear Stearns almost collapsed, the buysiders said.

“The biggest fear that I have . . . is the credit risk,” Miller said. “Thank goodness we have always been concerned about credit because we did own Bear.”

Miller said he was going to Hawaii when news broke that Bear Stearns credit was in trouble, and almost canceled his trip. But his clients’ credit exposure had been diversified beyond Bear Stearns and the bank was eventually bailed out, so Miller stayed in Hawaii.

But he said the important lesson for advisors is to spread their eggs. “There is no worse feeling when you are trying to hedge risks for your client,” he said.

For full coverage of SPA-2008 from Prospect News:
Click here for Day One (Wednesday, April 9, 2008)
Click here for Day Two (Thursday, April 10, 2008)