A small but growing number of advisers are turning to derivatives-based strategies to help manage increased levels of market risk.
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 observer.
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.
"There are a lot of risks that people don't take into account," said Matt Blecker, president of Nanuet, N.Y.-based Eastern Planning Inc., which has $125 million in assets under management. "I like the plain vanilla form of investing."
Despite receiving requests from his clients for structured products, Fred Ptucha, a broker with Financial West Group Inc. of Westlake Village, Calif., has stayed away from them because he is concerned about the risk. "I never touched [derivative-like products], thank God," he said. "I'm steering [clients] away."
RETAIL INVESTORS
With a willingness to allocate up to 20% of a client's portfolio to structured products, Mr. Wright is among the early adopters driving sales to individual investors.
So far, about 60% of structured-product sales have been to institutional investors, but as market conditions become dicier, the theory is that structured products will start to penetrate beyond the 10% of financial intermediaries who already own them.
"Going forward, we think that 60% of sales will be represented by the two-legged investors," said Keith Styrcula, president of the New York-based Structured Products Association.
The key to getting there — something the industry has struggled with since structured products started gaining appeal among advisers and retail investors less than five years ago — hinges upon efforts to educate financial advisers.
"This reminds me of the early 1980s when the industry first came out with variable annuities and all the brokers were dumbfounded," said Ryan Johnson, president of Foreside Advisory Network LLC, a third-party marketing firm in Canton, Conn.
While Mr. Styrcula initially shuddered at the comparison to the oft-controversial variable annuity market, he acknowledged that the complexity of the instruments, like variable annuities, could make it difficult for structured products to reach a wider market of advisers and investors.
A survey of more than 250 attendees two weeks ago at the SPA's fourth annual industry conference in New York showed that 40% did not own a structured product.
"There should be a lot more eating of our own cooking," Mr. Styrcula said. "In fact, it should be a distinguishing factor that you should not be selling a structured product if you've never bought one."
The weakness in sales, even among those working in the industry, underscores one of the biggest obstacles of structured-product marketing: The absence of a clear and concise message describing what a structured product is.
In addition to real concerns over liquidity, lack of transparency and an evolving maze of industry jargon, veteran advisers warn of the risks associated with the creditworthiness of the issuing firms.
"I caution anyone who uses structured products to diversify and don't just put all your money in the top three issuers," said J. Scott Miller, managing partner at Blue Bell (Pa.) Private Wealth Management, a firm that oversees $300 million in assets.
Diversification has helped Mr. Miller rest easy, despite exposure to some structured products issued by The Bear Stearns Cos. Inc., the New York-based firm that is about to be acquired by JPMorgan Chase & Co., also of New York.
'A CHILLING FEELING'
"The products are bonds backed by Bear Stearns and we expect to get paid, but something like [Bear Stearns' near-implosion] is a chilling feeling when you're in business to protect people," Mr. Miller said. "That's why we work with about 12 different investment banks, to diversify our portfolios."
Even considering the Bear Stearns example as possibly the worst-case scenario for a structured- products investor, Mr. Miller said the right kind of structured products could benefit investors at all levels.
"Certain sales practices scare me and suitability always must be considered, but I truly believe structured products are appropriate for most investors," he said.
What's stopping more advisers from adopting the strategies often boils down to an attitude of resistance.
"Registered investment advisers are a special group of people in that they think they're smarter than everybody else," Mr. Miller said.
That works just fine for many of the early adopters, like Tony Proctor, president of Proctor Financial Inc. in Wellesley, Mass.
"For us, the use of structured products has been a way to stop the bleeding and keep clients in the game so they didn't do something foolish like put all their money in a [certificate of deposit]," he said.
"Using structured products is really what our peer group should be doing right now, and I think five years from now a lot of clients will be asking their advisers why they didn't put them in structured products."
Reporter Andrew Coen contributed to this story.
E-mail Jeff Benjamin at jbenjamin@investmentnews.com.
