SPA Conference: Fiduciaries discuss the various methods, benefits of using structured notes

By Emma Trincal

New York, March 10 - Registered investment advisers offered some insights into how they use structured investments in their practice as fiduciaries during the "Fiduciaries: RIAs and Discretionary Assets" panel of the SPA 2014 Annual Structured Investments Distribution Conference held in New York on Monday. The conference was sponsored by the Structured Products Association.

Tim Mortimer, managing director at Future Value Consultants asked panelists to explain what would make an RIA use a structured product.

Toolbox

For Steve Doucette, financial adviser at Proctor Financial, the answer was to generate alpha in all markets while allocating the product to the right place in his overall portfolio.

"We're asset allocators," Doucette said.

"When we're long-only on a particular asset class, we want to add some level of protection. We typically seek to outperform on either direction of the market. It could be on the downside with a buffer or on the upside with some leverage.

"We also look at price dislocations in the market. At some point, we looked at the S&P versus the XLF, the financial ETF, and we found that it was at the largest spread we had ever seen. We worked on capturing the closing of the gap." The "XLF" symbol is the ticker for the Select Sector Financial Select Sector SPDR fund.

Tom Balcom, founder at 1650 Wealth Management said that "we're big advocates of structured notes" and that "we use them in our asset allocation as a substitute for our long-only exposure."

Eric Greschner, portfolio manager at Regatta Research & Money Management, said that he found several good reasons to use structured investments in his portfolio.

"It gives you the ability to create an asymmetric risk-return profile," he explained. "We can monetize different market scenarios - falling market, sideways market or rising market. We can also use it to diversify our risk management techniques."

The highest standard

As RIAs, these buysiders have to offer the products while being held to the fiduciary standard. Mortimer asked them to specify the implications of this responsibility.

"It's the highest standard," said Greschner.

"We have to shop and find the most attractive deals for clients. We're getting structured products ideally without a commission or with a discount. We have to make sure the product is suitable for the client and that everything is fully disclosed."

For Doucette, simplicity was one way to meet the standard requirements.

"I like to keep things simple," he said.

"We go out and buy the notes as if it was our own. We get the best terms, the best price. We want to be able to sell the notes on the secondary market. Our approach is: treat your client as well as you treat your mother."

Balcom said that compliance was a key issue.

"We pay attention to what the regulators are focusing on. Right now, they're focusing on suitability and pricing. Complexity is also a concern. They want to make sure that the adviser who sells the product has an idea of what they're talking about," he said.

Disclosure

Greschner said that his firm was particularly focused on disclosure and that an entire process had been established at his firm with the intention of reducing to a minimum the chances of miscommunication with clients.

"If someone is interested in investing in structured products we do everything we can to minimize the risk of any arbitration claim," he said.

His firm, he explained, has clients read not only the issuer's prospectus but also some of the firm's literature describing the pros and cons of the investments. At the end, clients are shown a document summarizing all the risks in "plain English" and they have to confirm in writing that they understood the disclosure.

"We send a simple metric explaining how much investors may lose if the index declines by a certain amount and we go through several examples," said Balcom.

"We keep it simple and we back it up with the prospectus."

Doucette said that his role in minimizing the risk was to carefully select the best investment possible for his clients.

Mr. Market

The complexity of some structures, suitability issues and pricing were among the challenges that advisers said they faced.

Pricing was perhaps the most sensitive issue at this point, the panelists said. But the market may evolve in ways that could soon resolve those problems.

"These leveraged notes aren't looking very good right now, they're not pricing very well," Doucette said.

"This five-year bull market is going to turn: the question is when. When that happens, we're going to need principal-protection and we may have new opportunities."

"There's no question that a market correction will increase demand for structured products. Rising interest rates would be very helpful," Balcom said.

"As interest rates rise, we should get better terms. We should also get reversion-to-the-mean performance.

Greschner added: "Rising volatility levels will also increase the appeal of structured products."

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