Page 19 - Investment Advisor January/February 2022

ALTERNATIVE INVESTMENTS

By Thomas W. Balcom

Why Structured Notes Might Be a Fit for

Some Clients

Advisors may think these products too institutional, but they would be wrong.

tructured products have the con- cess, which consists of providing a
notation of institutional or off- number of banks with four of the five
Sthe-grid usage for most advisors. possible variables and then having the
However, we’ve utilized structured banks provide quotes on the remaining
notes as a complement to long-only variable. Typically, we provide banks
mutual funds and exchange-traded with the underlying investment (e.g.
funds in client portfolios for years. S&P 500), tenor, downside protection
During the financial crisis, we used (20% buffer), upside leverage and then
them as a “repair and recovery” strategy have them solve for the upside cap or
in an attempt to recoup the losses that maximum return.
occurred in the fall of 2008. Currently, We limit our total number of struc-
we use them as a hedge within our cli- for the trade. The option portion can be tured notes to closely monitor their per-
ents’ portfolios. Structured notes can linked to a stock, index or ETF. formance via a biweekly update of an
be used to offer hedged or leveraged The simplest structured note avail- Excel matrix that helps us to determine
exposure depending on your viewpoint. able is a principal protected note that whether we need to hold or roll (sell and
But let’s start with the basics: consists of a zero-coupon bond and an reinvest) each structured note.
option tied to an index such as the S&P
WHAT ARE STRUCTURED NOTES? 500. If the stock market declines, you WHAT COULD GO WRONG?
These products are extremely flexible will receive your principal back but will Because notes are senior unsecured
investment vehicles that can be used in need to pay some original issue discount debts of the issuing bank, a default by
a variety of ways. They can be used as an (OID) on the zero-coupon bond. If the the issuing bank would severely reduce
income replacement vehicle, to hedge a index rises, you will participate to some the value of each note. But following
portfolio or to provide unique exposure degree in the gains. the Lehman debacle, the government
that is not available in traditional invest- rewrote the laws and the final two
ments such as mutual funds or ETFs. HOW CAN I PURCHASE A remaining investment banks (Morgan
Variables involved in this product are STRUCTURED NOTE? Stanley and Goldman Sachs) became
tenor (duration) of the note, downside These products can be purchased directly bank holding companies, which allows
protection (buffer or barrier), upside from their broker-dealer or custodian via them access to the Federal Reserve in
participation (leveraged or unlever- monthly offerings, or through a platform, times of financial stress. While this does
aged), underlying product (stock, index, such as Halo Investing. In addition, cus- not completely eliminate the possibility
ETF or other investment) and size tom notes can be created at values as low of default, it certainly reduces this par-
(notional amount) of the trade. Advisors as $500,000. Because notes can be broken ticular risk to investors.
need to have a view of the stock market down into $1,000 increments, our firm
or individual security before requesting typically creates customized structured Thomas W. Balcom, CFP, CAIA, is founder
pricing of a note. notes with a value between $2 million to and head of 1650 Wealth Management, an
$3 million and then allocates across vari- RIA that is a power user of structured notes,
HOW IS A STRUCTURED NOTE ous client accounts depending on their accounting for 50% of client portfolios. The
CREATED? asset allocation and portfolio size. firm is located in Lauderdale-by-the-Sea,
Structured notes contain essentially two WHAT ADVICE CAN WE GIVE TO NEW Florida. To hear more on this topic, please
Adobe Stock multiple option(s). The bond portion of USERS OF STRUCTURED NOTES? listen to: Beyond Markowitz: Personalizing
components: a bond and a single or
Your Practice and Client Experience with
We recommend a reverse inquiry pro-
the structured note serves as collateral
Structured Investments at thinkadvisor.com.

JANUARY/FEBRUARY 2022 INVESTMENT ADVISOR 17