What’s Ahead

Alternative investments have grown markedly in the past several years, and the retail crowd has gotten involved.
Concerns are on the rise among regulators and investors, however.
Structured Notes can be an “alternative to alternatives” for advisors and may help clients reach their financial goals more effectively.

Financial markets went through a much-needed reset following the speculative bubble that was apparent in late 2020 and 2021. Back then, cryptocurrencies launched like wildfire as bitcoin and ether took off like rocket ships, meme stocks were going to the moon, and the IPO market was red hot. Stocks and bonds were also in full flight, rewarding both investors and advisors.

Record-low interest rates resulted in excess dabbling in markets that were off the beaten path. The fervor grew too intense, and a bear market ensued in early 2022. While it was nothing like what we all experienced in 2008, the sting of lower asset prices, frustrated clients, and smaller revenue for advisors was real. Today, with recoveries in both the equity and fixed-income spaces, advisors may be looking to spread out exposure in case of another significant pullback.

But what if the next growth opportunity isn’t all that much different from what you as an advisor already know well? Structured Notes have the potential to deliver high-income returns for risk-sensitive clients while also meeting the needs of investors with more aggressive targets. Moreover, rather than diving headlong into the complex world of high-fee, overly complex, and illiquid alternatives, financial professionals commonly price Structured Notes based on equity and bond market indexes, which makes them easier to discuss with clients.

Let’s outline why clients seeking to preserve their wealth should view Structured Notes not only as a win but also as a growth driver for financial advisors.

Alternative Investments: A Growing Pie …

Gone are the days of alternative investments being reserved for high-net-worth families and institutional investors. Retail demand has been impressive over the past handful of market cycles, and advisors continue to sort out the good from the bad across alternative sub-asset classes.

According to the CAIA Association, the alternative investment universe grew to $22 trillion in assets under management as of late 2023, or 15% of global assets._¹ Not only is the pie expanding, but new slices are being added all the time.

You may have heard of the “factor zoo” when it comes to stock market smart-beta plays, but niche “alts” emerge from the wilderness constantly, even with higher interest rates today. Along with private equity, hedge funds, real estate, infrastructure, and natural resource alts, private credit in particular has risen in prominence.

Investors used to harness alts for their diversification advantage when market volatility struck. Complex strategies and opaque asset types were believed to retain their value, or even appreciate, when stocks headed south. But the prolonged bull market of the 2010s shed light on the reality that missing out on a historic rally can be just as, if not more, perilous than participating in an equity bear market. Jump ahead to today, and investor applications of alts are more nuanced.

Hedge funds, private equity, private credit, and venture capital still aim to deliver superior growth opportunities and non-correlated returns while smoothing out volatility, but income generation appears to be higher up on investors’ pecking order. The boom in private credit has resulted in the proliferation of closed-end funds, and regulators are keeping their eye on that emerging marketplace. Morgan Stanley now estimates that private credit is a $1.5 trillion market, growing by 50% from 2020 to 2024. Estimates call for it to nearly double by 2028.²

Technology and an overall push of alts toward the mass affluent market, along with new investor applications, has indeed propelled this once small corner of the investable universe into the spotlight – even after the recent stellar rally in the S&P 500. High and steady income streams, protection against the downside, and participation in bull markets are the demands of modern clients. That’s a high bar to leap, though. In the effort to jump such hurdles, risks must be weighed.

… But Regulators and Investors Remain Concerned

Amid alts’ allure of higher income returns, diversification benefits, and access to private markets, concerns increase regarding the market’s size and what systemic risks could present themselves in the cycles ahead.

Market Risk: In August 2024, the Federal Reserve (Fed) published an article, “Private Credit Growth and Monetary Policy Transmission,” which cautioned that monetary policy may have a muted impact due to the structural features of that asset class.³ The Fed also noted that growth in private credit could potentially amplify financial system risks.
Transparency Issues: Regulators may be worried about limited disclosure requirements among venture capital, private equity, private credit, and hedge funds. An ongoing challenge for regulators and investors is to gauge risks accurately.
Investor Protection: As alternatives forge their way into retail client portfolios, concerns about investor protection only become larger. Individuals may not fully understand the myriad risks associated with complex alt strategies.

The regulatory body isn’t the only one that takes issue with alts’ rise to prominence. Critics are quick to point out a host of drawbacks from the end-investor’s perspective, including liquidity constraints, high fees, complexity, valuation accuracy and timeliness, and overall limited transparency.

Structured Notes as an “Alternative to Alternatives”

As worries grow from both lawmakers and self-regulatory organizations in the investment community, Structured Notes gain attention as a potential solution that addresses some of the issues outlined above while still delivering what retail clients demand.

As mentioned before, a Structured Note is a relatively straightforward vehicle. It contains a long bond position issued by a major financial institution and an options package, usually priced off a market index or highly traded asset or basket of securities. Notes can be designed to provide a range of payoff profiles, but are commonly used for downside protection, high yields, and enhanced returns.

When considering alternative investments, there are several advantages of Structured Notes:

Enhanced Liquidity: Structured Notes don’t feature multiyear, lock-up periods common to typical alts. They have shorter maturities, usually ranging from a few months to a few years. While they’re designed to be held to maturity, there are also secondary markets, which offer the potential for a noteholder to exit before maturity, if necessary.
Enhanced Transparency: Unlike many alternative investments, Structured Notes are valued based on publicly traded securities or indices, with clearly defined terms and payoff profiles. What’s more, retail clients can track their performance to better grasp how market movements impact their returns. Unlike many alternative investments, daily valuations from the major issuers of Notes are now available.
Reduced Complexity: Structured Notes’ defined-outcome nature makes them particularly appealing for retail investors, whereas typical alts are a bit more of a black box in terms of near-term performance drivers.
Lower Fee Structure: Structured Notes often have lower overall costs compared to the combined management and performance fees of many alternative investments. The fee structure is typically more transparent, with the cost embedded in the Note’s pricing.
Broader Accessibility: Among the greatest appeals of Notes is that they have lower minimum investment requirements compared to hedge funds, private equity, private credit, and venture capital funds.
Customization: Another unique aspect of Structured Notes is that they can be tailored to provide specific risk and return outcomes based on an individual investor’s preferences. For advisors employing goals-based investment strategies, Notes can be an ideal solution for a range of client types.

Structured Notes + Alternative Investments

It’s key to point out that advisors seeking diverse sub-asset classes and vehicles for their clients do not have to choose one or the other. The common set of alternative investment types and Structured Notes can work in tandem within a portfolio.

Ultimately, it’s up to the advisor to determine how much complexity they desire as they aim to address client needs, expand their customer base, enhance their existing relationships, and gain a competitive advantage in the industry.

The Bottom Line

Structured Notes emerge as a high-growth opportunity for financial advisors, even as typical alternatives go mainstream. Increasing regulatory scrutiny and investor concerns about traditional alts are risks, while Structured Notes could be a more optimized vehicle to help everyday investors reach their financial goals.

With proper client education and portfolio implementation, Structured Notes have the potential to be a valuable tool in the modern advisor’s tool kit, driving practice growth and making for better client experiences.

SOURCES

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 investor’s 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.

US301/1.0/2410