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Structured products flourish in today's 'choppy market'
Investment adviser area seen as 'Holy Grail' for future growth
The structured-products industry has been relatively obscure among most U.S. investors and financial advisers, but lately, it is basking in the glow of a record-setting 78% increase in 2007 sales.
The $114 billion in sales has surprised even some industry insiders, who have watched annual structured-product sales climb steadily from $28 billion in 2003, according to the Structured Products Association, a New York-based trade group.
"We saw our business explode last year," said Tom Ricketts, chief executive of Incapital LLC, a Chicago-based investment-banking firm that markets structured products to brokerage firms and advisers.
"Financial advisers are looking for more non-correlated assets," he added. "Banks [that manufacture structured products for sale] are getting very creative, and companies are doing a great job of educating consumers and advisers."
In the most general sense, structured products involve the use of derivatives to meet specific investment objectives. The idea is to create an investment product that combines equity and fixed-income features — namely, upside potential with downside protection. This is accomplished by creating a basket of investments that can include bonds, certificates of deposit, equities, commodities, currencies, real estate investment trusts and derivatives products.
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.
A QUESTION OF SUITABILITY
Last year's record growth, according to the industry, is a result of the momentum that marketers and manufacturers of structured products have been struggling to build.
"We like to have a lot of structured products in our clients' accounts," said Scott Miller, managing partner at Blue Bell (Pa.) Private Wealth Management LLC.
About 40% of the firm's $300 million under advisement is currently allocated to various structured products, he said.
"We think we can get good diversification this way," Mr. Miller said. "I'm a big believer in structured products when they're used properly."
There are exceptions, however.
"I see a lot of growth coming in reverse convertibles, and I don't like that trend. A lot of individuals might not understand how much risk they're taking on," Mr. Miller said. "It's a matter of suitability."
Reverse convertibles typically create regular interest or coupon payments on an individual stock in exchange for some of the stock's performance over a designated period. But the stock price could decline to the point where the interest payments aren't enough to cover the loss. In some structures, if the stock drops to a certain level, the investor could lose the full value of the shares.
One of Mr. Miller's current favorites is a buffered-return enhanced note with a 13-month maturity that protects principal up to a 10% decline in the Standard & Poor's 500 stock index.
Investors in these particular products participate in gains but will absorb any loss beyond 10%.
It is one example of the kind of customization that is coming into the market to meet specific economic conditions.
"People are seeing the value in structured products because [they] are enormously popular in a pretty choppy market," said Serge Troyanovsky, New York-based director of equity and derivatives for Paris-based BNP Paribas.
He cited the bank's recently issued triple-appreciation notes that offer three times the upside of the S&P 500 for a set period, and full downside exposure.
"A lot of structured products are used as substitutes for an index," Mr. Troyanovsky said."In a single-digit-growth environment, these types of products can look very attractive."
The industry, represented by the five-year-old Structured Products Association, has helped fuel growth by orchestrating an educational campaign that takes its message both to financial intermediaries and consumers.
Even though structured products are sold almost exclusively through brokers and advisers, the industry realized that it needed to develop some investor appetite for a product that has yet to hit the mainstream despite minimum investments of as low as $1,000.
"In the global context, the United States is well behind with regard to structured products," said Guy Gregoire, director of the trading services group at Pershing LLC in Jersey City, N.J.
Although common in Europe and parts of Asia, structured products only recently started gaining traction in the United States, where the number of banks issuing them has tripled to 30 since 2001, according to Philippe El-Asmar, head of investor solutions at Barclays Capital, the New York-based investment-banking division of Barclays PLC, which is based in London.
A survey of attendees at the 26th Annual LaSalle Fixed Income Symposium last month in Boca Raton, Fla., hosted by LaSalle Bank Corp. of Chicago, showed that at 61% of firms, less than 5% of the brokerage reps were actively selling structured products.
Part of what has the industry so optimistic is that the record-setting growth rate has been accomplished with an estimated 10% penetration of potential financial intermediaries.
"There is more education and consumer awareness now, and there are more players now in the business," Mr. El-Asmar said.
"Right now, it seems like investor demand is the biggest driver," he added. "But the [independent-adviser] space represents the Holy Grail."
Keith Styrcula:
Focus should be on simpler, more transparent products, he says.
But reaching the highly fragmented market of independent advisers will require more than just education and marketing, according to Keith Styrcula, president of the Structured Products Association.
"We know we still have a few things to fix in our industry," he said.
"At this point, there might be an overemphasis on education when what we really need to focus on is creating simpler and more transparent products," Mr. Styrcula said.
To that end, the association last year introduced a "nomenclature initiative" to encourage nearly three dozen banks to start calling similar products by the same name.
So far, little progress has been made.
"The best structured products are a little more plain vanilla, so people can understand what they are," Blue Bell's Mr. Miller said.
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