Structured product dealers have for years been frustrated at the unwillingness of US retail and private investors to accept their offerings. But at least one large product distributor, Florida-based Countrywide Financial, believes the tide may finally be about to turn, and aims to be in a leading position to take up demand when it does. "We're working very closely with several European banks to see what structures have been successful with retail investors in other countries and find ways in which we can transmit those benefits to American investors," says Countrywide's senior vice-president and manager for special products, Kevin Mahon.
"We want to have products on the shelf at all times," he continues. "People need to broaden their exposure as investment markets become increasingly interconnected. We are trying to educate the traders at other firms and show them the value that products such as these can provide their customers."
Mahon is upbeat about the growth potential of structured products in the US, but says the region lags far behind Europe, Asia and Latin America in terms of how they are viewed by investors and the advisers. "I don't think people realise that these products can actually lower their risk and volatility exposure," he says. "Europe has always been much more comfortable with contracts and with securities that are customised to their needs. There's maybe a little bit more depth and sophistication in the European market, and they're much more used to cross-border transactions. The US has never had that depth, and until recently there has been no need for the US retail market to look outside of its borders."
Countrywide is working with SG and BNP Paribas, among others, to broaden the appeal of structured products in the US. It plans to distribute a number of equity-linked structures and even foresees more exotic underlyings appearing at some point. But the company appears to have a lot of work on its hands if it is to win the confidence of the US advisory community. Take, for example, James Berliner, a partner at Los Angeles-based Westmount Asset Management, which has been advising wealthy US private investors on what they should be doing with their money since 1990. Like other US wealth advisers, Berliner has a deep-rooted skepticism of structured notes, and in particular capital-guarantees. "I've seen these products. They're often offered by banks, and I've seen some that are tied to elements of the S&P 500, but we've just never seen that much interest in them," he says.
"They were somewhat popular around two years ago in the depths of the bear market, when people really grabbed onto the guarantee," Berliner adds. "But they got a fair amount of negative press from some financial writers who said they were leading people to believe they could have it all – the guarantee of a bond or certificate of deposit and also the upside of the stock market. But they weren't really giving the full upside of the market. They were maligned as being gimmicky and unreasonable, because there's no free lunch out there."
Berliner is not alone is his cynicism. Alan Robertson, Chicago-based group head of wealth advisory services at Northern Trust, says: "When you get to the personal markets, people have different constraints and different outlooks, so it is difficult to come up with what I would call a prescribed structured product for them."
Jim Blair, principal at St Louis-based advisory company Moneta Group Investment Advisors, says structured products can simply appear too complex for US retail investors. "Each one is packaged differently and has different underlying collateral, so it takes your average investor a while to get their head around it," he says, adding that it is difficult to see how structured products fit in a portfolio allocation scenario. "These things don't fall into any particular style box when you are doing financial planning or asset allocation – it's not a bond, it's not stock, it's not alternative, so what is it?"
Berliner believes the average US wealth adviser would rather stick to traditional money management techniques that do not involve the use of structured notes. "We would rather build a portfolio that puts the conservative assets where they belong and the equity and aggressively riskier elements where they belong, rather than use a type of product that has costs and limitations," he says.
Westmount describes its long-term investment approach as equity-oriented. It tends to invest its clients money in bond and stock mutual funds and attempts to control risk through diversification. On the riskier side, it has a venture capital and private equity division and claims to be one of the few firms in the US that provides individuals with access to a diversified portfolio of private equity investments, via its own in-house pooled fund.
Many private wealth advisers seem to believe that capital-guaranteed products are essentially too conservative for the majority of affluent Americans. They say Americans have been investing in equities for so long that they are as a rule happy to accept a higher level of risk than their European counterparts, despite still feeling the effects of the burst technology bubble. By contrast, many European private investors, especially those who are not high-net-worth individuals, have only really come round to investing in equities in the last 20 years. "I think people here have a real understanding of the downside that equity markets contain and so are more prepared to accept it," says Berliner.
"I'm sure those guaranteed notes are being bought by the 50- and 60-year-olds in Europe," adds Kevin Robins, senior executive and head of wealth management solutions at investment company SEI in Oaks, Pennsylvania. "I think the major issue with guaranteed products is that you're giving up so much upside for the level of insurance they provide. Clients are looking for certainty that their goals are being met, but I just think there are different ways that those goals are met in the US."
Robins says SEI offers its clients strategies that are designed to provide insurance through diversification, thereby rendering capital-guaranteed products redundant, especially for affluent investors. "We've done historical and prospective analysis and concluded that you're paying so much for insurance that you really have no upside," he says. "We believe that if you do the allocation process properly and manage the money in a way that gives confidence then you don't need the extra insurance."
SEI is one of the US's biggest providers of 'multi-manager' products. Robins says it is this kind of investment, rather than structured notes, that his clients are looking for. The investment strategy is similar to a fund-of-funds approach in that it consists of a portfolio manager that places money with underling money managers. The difference is that rather than investing in funds alone, the multi-manager contracts directly with the underlying managers, which then run a separate account for it. "You could say this is in direct competition to structured products," says Robins, adding that the approach is becoming increasingly popular with US private investors.
"Our strategy is designed to provide security but with a lot of flexibility," he says. "Once you are in one of those [structured] products, it's usually for a fairly long time period, so if your situation changes and you decide you need more money it can be difficult to get out. With our strategy the client has constant liquidity."
And anyway, says Robins, if US investors really do require additional insurance, then they can achieve it with products other than structured notes. "Variable annuities are popular here and are designed to create consistent cashflow," he says. Variable annuities provide investors with periodic payments for the rest of their lives, and are useful as a retirement management tool. The value of a variable annuity depends on the performance of the investment options the owner chooses – typically these consistent of mutual funds that invest in stocks, bonds, cash market instruments, or a combination of the three. Investors can choose the combination themselves, so they can take as much exposure to equities as they want while maintaining a safe cash pile. Importantly, variable annuities are tax-deferred, so investors pay no tax on the income and investment gains from their investment until they withdraw their money. They can also transfer their cash from one investment option to another within the variable annuity without paying tax at the time of the transfer.
"I think the major issue with both types of products, guaranteed products and variable annuities, is that to get the guarantee you have to give up so much upside," says Robins.
Blair agrees. "My feeling is, why should the investor give up 20% or 30% of the upside of that stock growth? And then you have to think about inflation. If we get into an inflationary period and you're locked in on the low end of that deal at 4% or 5%, and you don't get the performance on the upside, then you've lost money in real terms."
Finding a niche
Countrywide's Mahon accepts that many US investors and advisers remain wary of capital guarantees, but he insists that they have a place in a diversified portfolio. " People are beginning to realize that this is a less expensive and less complicated way to tailor something to their specific needs," he says. "There's growing acceptance that they should form some part of a portfolio. We're hearing numbers like 5% to 15%." He adds that structured products can be a more efficient way for investors to make specific plays, such as on currencies or commodities.
But Mahon says attitudes still need to change. "I think a major stumbling block is that these products fall under the term derivatives. That word is very common and positively accepted in Europe, Latin America and Asia, whereas in the US it has only been exposed to the public in a negative light. When there's been some kind of crisis it's been blamed on derivatives exposure."
Mahon says derivatives need to be defined in a positive light so that investors identify them more with risk reduction than risk-taking. He believes that despite the prevailing skepticism the future for structured product makers and distributors in the US will ultimately be a rosy one. "The US market is in its very early infancy in terms of these products, but I think the growth curve over the next five years will be tremendous."
He may well have a point. Earlier this year, the US structured products business received a boost when SG Corporate & Investment Banking (SG CIB) signed a purchase agreement with Bank of America to acquire its structured investments business, which provides financing to fund-of-fund companies that invest in a variety of hedge funds on behalf of institutional investors and high net worth individuals.
No price was disclosed but sources estimate SG paid around $50 million and the business has around $6 billion under management. The deal comes just eighteen months after SG bought another US structured products firm - Constellation Financial Management. In fact, the deal is being viewed by many as a further attempt by SG to fight off fierce competition from French rival BNP Paribas in New York. In 2003 BNP bought out the fund platform of Zurich Capital Markets and observers say that purchase has been successful.
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