What’s Ahead
- As an โalternative to alternatives,โ Structured Notes can offer better liquidity, transparency, and lower fees than many traditional alternative investments.
- Structured Notes are less complex and more accessible to a wider range of clients compared to Venture Capital, Private Equity, Private Credit, and Hedge Funds.
- Advisors can use Structured Notes as a complement or alternative to traditional alts to build diversified and flexible client portfolios.
There has been a boom in certain areas of the alternative investment universe. Years of low interest rates followed by the Federal Reserveโs historic rate-hiking campaign in the wake of post-pandemic inflation turned out to be the recipe for investors seeking new sources of risk-adjusted returns. Venture Capital, Private Equity, Private Credit, and Hedge Funds have gone through significant changes over the last few market cycles, and investors and advisors might wonder if there are simply too many folks fishing in these ponds.
While each alternative investment type offers its own set of benefits, challenges also arise. Itโs no secret that liquidity can be problematic with alts, transparency risks are apparent, thereโs added complexity, fees tend to be high, and not all investors can access the full range of alternatives.
Structured Notes, on the other hand, provide an intriguing โalternative to alternativesโ in the sense that they address many of these concerns while still aiming to deliver compelling risk-adjusted returns.
Compared to, or even alongside, common alternative investment types, we make the case that incorporating Notes into client portfolios can make sense for five key reasons:
1. Enhanced Liquidity
Perhaps the biggest drawback to the alternative investments is their illiquid nature. Venture Capital and Private Equity funds commonly lock up capital for seven to 10 years, while Private Credit may restrict investorsโ access to their funds for three to seven years, depending on loan agreements. Hedge funds, meanwhile, are moderately more liquid compared to other alternatives, offering quarterly or annual selling windows, but with notice periods ranging from 30 to 90 days.
Structured Notes, by contrast, feature significantly improved liquidity. While there are certain terms and defined maturity dates with Notes, those periods are usually shorter than lock-up durations and long-dated, exit-strategy horizons common with traditional alternatives. Most
Investors facing unexpected financial needs require liquidity in their portfolios. That reality can limit potential exposure to common alternative investment choices, but Structured Notes have better flexibility. While Notes are designed to be held to maturity, they can be used for a variety of both short-term and long-term client goals.
2. Improved Transparency
Alternative investments sometimes score poor marks when it comes to transparency. This isnโt a ding against the group as a whole, it is just the nature of the investments. Consider that private companies do not have the same reporting requirements as firms trading on public markets. The result is that itโs hard for analysts and advisors to fully understand the holdings of alt funds.
For instance, Venture Capital funds often involve seeding early-stage firms and startups that offer limited insight into the underlying operations, financial health, or valuation methodologies of their portfolio companies. There may be only periodic updates on performance, making it a challenge to gauge the portfolioโs real-time value. Similar transparency issues are seen with Private Equity and Private Credit. Hedge Funds offer more financial insight, but they still operate with limited disclosure, particularly regarding their strategies โ investors end up relying on what fund managers report.
Structured Notes can be more transparent relative to alts. That claim is backed up by the assets that comprise Notes โ a long bond position and an options package. Each Note is valued on publicly traded securities or indices, with defined terms and payoff profiles. Both advisors and investors can track the performance of a Noteโs underlying assets and grasp how it might perform under various market scenarios. Rather than waiting for a valuation date or exit event, noteholders can use daily market-pricing data to accurately assess investment performance.
3. Reduced Complexity
Alternative investments often feature sophisticated strategies that sound elegant on paper โ and they often accomplish what they seek to provide โ strong risk-adjusted returns. A problem arises when market conditions turn unfavorable, however. Advisors can have a challenging time explaining why a particular alternative investment strategy did not perform well, resulting in a loss of client confidence. Misaligned expectations and possible dissatisfaction are potentially negative byproducts of altsโ complexity.
For example, Private Credit has been a popular niche of the alternative universe in the last few years. But these loans involve privately negotiated terms, resulting in low visibility into underlying assets. Similar issues arise with Private Equity deals, though you sort of know what you are getting into with Venture Capital investments. As for Hedge Funds, there are several categories of hedge-fund strategies that even experienced financial analysts may have a tough time pinning down when it comes to how returns are earned and what macro and micro risks are most significant at any given time.
Structured Notes feature many of the same diversification benefits, but they are easier to understand for everyday investors. There are just a few terms to learn, and advisors can hold more straightforward discussions about risk and return with Notes. The results are better-informed discussions between advisors and clients and an actionable, goals-based investment solution.
4. Lower Costs
The elephant in the room is the topic of fees. Alternative investments are notorious for their high costs compared to stock and bond funds. Venture Capital, Private Equity, Private Credit, and Hedge Funds involve expert strategies and access to targeted investments, and investors pay a premium for that. Each group may have a management fee from 1.5% to 2.5% as well as a performance-based fee that could be 10% or more of profits above a stated hurdle rate.
For example, a typical Venture Capital Fund might charge a 2% annual management fee on committed capital and a 20% carried interest fee on profits above a certain hurdle rate. Similarly, Private Equity groups and Hedge Funds often follow a “2 and 20” structure โ a 2% management fee and 20% of profits.
Structured Notes feature lower overall costs. While fees are embedded, they are typically lower than the combined management and performance fees of many alternatives. Furthermore, the fee structure is direct, and the investor does not have to give up potential profits as they might with high performance-based fees of alternatives.
5. Broader Accessibility
Thereโs no doubt that the past decade has been revolutionary when it comes to bringing alternatives to the masses. Once reserved for high-net-worth families, alts are now more available for advisors to offer to their mass-affluent clients. Still, there are regulations that limit access to accredited investors while many alt investment funds have minimum investment thresholds that restrict access to only the very wealthy.
These barriers to entry are not found in Structured Notes. Investors big and small can tap Notesโ potential diversification and protective investment benefits. The appeal can indeed span the investor-wealth level, too. Take a risk-conscious retired couple with a modest portfolio and a Social Security income stream โ an advisor might choose an Income Note designed to enhance yield while protecting against market losses. At the other end of the spectrum, a high-net-worth client might request a specific Structured Note to diversify away from traditional market risks.
Itโs easy to understand why Structured Notes are increasingly popular with advisors who either work with a niche client group or serve a diverse client base. Notes can be incorporated into portfolio construction for a variety of investor segments, potentially cutting down on research time that would be required when investing in traditional alternatives. Put simply, Notesโ broader accessibility is more scalable for advisors.
The Alternative to Alts
Given these relative advantages, Structured Notes present an attractive โalternative to alternativesโ for advisors. The benefits are comparable โ strong return potential and portfolio diversification. The inherent drawbacks with Venture Capital, Private Equity, Private Credit, and Hedge Funds are less apparent with Structured Notes, however.
As a protective investment solution, Notes allow for tailored exposure to a range of asset classes, markets, and themes, much like what alternatives aim to deliver. Notesโ downside risk mitigation, enhanced yields, and upside participation are easier to discuss with clients.
We also encourage advisors to consider that Structure Notesโ flexibility, including a broad set of potential underlying assets, maturity dates, protection levels, and participation rates makes them like a Swiss Army Knife โ a tool to help meet a variety of client goals.
Yet, it’s important to point out that Structured Notes are not without their own set of risks. They can be complex products with credit risk tied to the Noteโs issuer, and their performance is dependent on the underlying assets or indices. For many clients, though, these risks may be more manageable and understandable compared to those associated with traditional alts.
Another consideration is that advisors do not have to choose between alternatives and Structured Notes. The two investment vehicles could fit together in an investment plan, acting as complementary, not competing, strategies. For clients who prioritize liquidity and transparency, leaning more toward Notes could make sense.
The Bottom Line
Alternative investments have grown in popularity and have become more widely available in recent years. Certain areas, like Private Credit, have soared in size just recently, leading advisors to wonder if risk-adjusted returns will deliver on lofty promises. Itโs hard to say for sure how that will unfold for retail clients, but Structured Notes can offer a compelling middle ground between traditional investments and alternatives. Compared to alternatives, Notes are available to a wider range of clients and feature better liquidity, improved transparency, less complexity, and lower fees.
In summary
| Benefit | Structured Notes vs. Alternatives |
|---|---|
| Enhanced liquidity | Structured Notes have shorter terms (months to a few years) and can trade on a secondary market, offering more liquidity than Venture Capital, Private Equity, and Private Credit, which often lock up capital for three to 10 years. |
| Improved Transparency | Structured Notes are based on publicly traded securities with clear terms, allowing for daily tracking of underlying assets. In contrast, alternatives like Venture Capital, Private Equity, and Hedge Funds often lack real-time transparency. |
| Less Complexity | Structured Notes are easier to understand with fewer terms and clearer risk-return profiles compared to more sophisticated alternative strategies like Private Credit and Hedge Funds, making them more approachable for everyday investors. |
| Lower Costs | Structured Notes have embedded fees that are generally lower and more straightforward than the high management and performance-based fees (e.g., โ2 and 20โ model) seen in many alternatives like Private Equity and Venture Capital. |
| Broader Accessibility | Structured Notes are available to a wider range of investors, including non-accredited investors with lower investment thresholds, compared to traditional alternatives, which often require high minimums and restrict access to accredited investors. |
Please see our Halo Disclosure Page for important disclosures.
An investment in Structured Notes may not be suitable for all investors. These investments involve substantial risks. The appropriateness of a particular investment or strategy will depend on an investorโs individual circumstances and objectives.
Content and any tools discussed are provided for educational and information purposes only. Halo Investing makes no investment recommendations and does not provide financial, tax, or legal advice. Any structured product or financial security discussed is for illustrative purposes only and are not intended to portray a recommendation to buy or sell a particular product or service.
US300/1.0/2410
