Cramer & Rauchegger's Scott Cramer uses structured products, fixed annuities to mitigate risk

By Emma Trincal

New York, Aug. 22 - Scott Cramer, president of Cramer & Rauchegger, Inc. in Winter Park, Fla., told Prospect News that he uses both structured products and fixed-income annuities to mitigate risk and provide income for his risk-adverse clients in retirement or pre-retirement.

"We think both instruments are a good fit for our practice because for our clients, preservation of principal" is most important, he said "Our clients can't afford the losses."

Cramer said that he has a diversified range of durations for the portfolios of his investors.

"Our clients are retired or close to retirement. That's our niche. The short term would be less than three years, then three to six for the medium term and a long-term horizon of seven to 10 years," he said.

"So we can use either one of them: structured products or fixed-income annuities."

Fixed annuities

Fixed index annuities, Cramer said, are very similar to structured products in that they offer upside potential tied to the market while providing for downside protection.

A fixed-income annuity is an investment vehicle considered very low risk in which an insurance company in exchange for a lump sum will pay an annuitant a guaranteed interest payment for a determined period of time.

"The main difference between many structured products and the fixed-income annuities is usually the calculation method," Cramer said.

"The fixed index annuity usually offers some sort of annual reset design, which means that gains are calculated on an annual basis. If they make money, the profits are locked in and don't go down. If they don't make money, you look at the next year."

Duration is another difference.

"Usually, the fixed-income annuity has a term comprised between five and 10 years. It tends to be longer than a structured product."

Cramer said that fixed-income annuities and structured products have their own pros and cons.

Among some of the advantages of annuities, he said, is the tax-deferred treatment of the gains.

Annuities may also offer some degree of liquidity, he said.

Many fixed annuities allow investors to withdraw a certain percentage of their account, usually around 10% a year, he said.

"Annuities offer a little bit of liquidity while structured products aren't that liquid at all," he said.

On the other hand, structured products tend to have shorter durations.

"The timeframe is different. Usually, a structured product has a one- to five-year tenor. A good annuity these days will have a seven-to-10-years timeframe. There are still many that have an even longer term, which we don't recommend," said Cramer.

"Both products are long term, even if annuities tend to be longer.

"As you know though, the pricing of these products is interest-rate driven. As interest rates have gone down, the issuers have to increase the length in order to price profitable products."

Principal protection

Cramer said that his firm started looking at structured products six to seven years ago.

"We had been using fixed-interest annuities and were looking for other ways to mitigate risk for our clients," he said.

Cramer & Rauchegger offers both market-linked certificates of deposits and principal-protected notes, he said.

"CDs give FDIC insurance, so our clients like that. We like it too, but it doesn't have to be FDIC-insured systematically. We do notes too," he said.

"Our clients look for structured products as a tool to mitigate risk while getting some of the market upside. They seek to enhance yield and outperform the returns they would normally get in a traditional CD or fixed-income instrument."

Lately, Cramer has noticed that some products have become less accessible than they were before.

"For fully principal-protected products, the market has become very limited as of late," he said.

"We still see some decent HSBC CDs tied to baskets of stocks. This type of product is the place to look for added yield.

"We also like to have assets in a portfolio that are non-correlated to the market. This will increase yield and reduce the overall risk."

CD versus cash

Another important aspect of being a financial planner is explaining the product to the client.

"Take the example of a CD linked to a basket of stocks with an autocap for the calculation of the return of each basket item," he said.

"The investment in itself is not good or bad. It depends on what the goals of the client are.

"It's very important to educate your clients about those products and to explain to them that they're not going to get equity-like returns but hopefully a good yield while avoiding losses.

"Some people out there are mis-positioning these securities, selling them as if they were stocks or mutual funds.

"In reality, the goal with equity-linked CDs is not to get equity-like returns. Your goal is to outperform a CD or cash.

"If you hit a 9% [autocap] for two out of four years, you did well."

Market-linked CDs differ from their plan vanilla counterparts in several ways, one of which being the variable coupons.

"With some of those CDs, you may not know how much your interest is going to be or if you're going to be paid at all on any given year," said Cramer.

"But when explained properly, this is not really an issue as investors look at the yield over the totality of the term of the investment.

"We generated 9% to 10% last year in some of our fixed-index annuities. This year, we may not make any money. But again, it is the total return over the investment period. Also, we need to keep in mind we are avoiding losses."

Shopping cart

Looking forward, Cramer said that he will have to adjust to some of the recent supply developments.

"We will start looking at notes with partial downside protection in this market because the supply of principal-protected notes is getting really slim," he said.

Buffers are becoming less and less plentiful, he said.

"Issuers tend to offer barriers rather than buffers as the option is less expensive. But we prefer buffers because they offer a higher level of protection," he said.

"If we were to design our own note, we would be looking at a two to four year with some potential upside, a high cap and a good buffer.

"Right now, we are looking for some commodities-based notes because we think that commodities are not as correlated to stocks as other assets.

"In terms of underlying, our preference goes to broader indexes and baskets of 10 to 12 stocks."

Credit diversification wanted

Cramer said that he gets his offerings through his broker-dealer.

"We have preferred providers too. I receive e-mails," he said.

"Some concerns we have is that we're shown a lot of the same issuers.

"I would like to be able to see all the issues in one place. If I could call the issuers or their distributors myself, it would be much better too."

In general, Cramer said that both structured products and fixed-income annuities have served the needs of his conservative clientele.

"Overall, with structured products and fixed-interest annuities, we've had a series of very good years," he said.

"The market itself was volatile, and we did a good job at still generating growth and yield while protecting our clients' money."

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