What the Halo sits down with Lou Mandia of Morgan Stanley joins What the Halo to discuss what’s working in risk management today. We cover Morgan Stanley’s advisor solution team and how they’re helping advisors make the most of concentrated equity positions, as well as other ‘champagne’ problems unique to today’s market environment.

For more information on Hedging & Monetization strategies or to get in touch with Halo and Lou Mandia, please visit our resource center here.

Please note that 3rd party views, opinions, commentary, and materials presented herein does not reflect those of Halo Securities, LLC, its employees or affiliates.

Read the full episode transcript below:

David Townsend, CFA: Welcome back to the What the Halo podcast. I’m your host, Dave Townsend. Today, we’re talking equity risk management with Lou Mandy of Morgan Stanley. You don’t wanna miss this one. Alright, Lou. Thanks for joining the show today. What the Halo? Thanks for coming on.

Lou Mandia: Absolutely, David. Thanks so much for having me today.

David: Yep. Well, this is, we’re it’s an honor to have you. It should be I hope it’s an honor for you too. We’re, you, the fastest growing, podcast for structured investments. So that’s, but it is a joke because we might be the only one right now, but, it’s it’s catching on. So but, thanks again for finding time here. We’re really thankful. I know you’re very busy, and, so we’re really grateful for you finding some time.

Lou: My pleasure. Always happy to, to help one of our closest partners here at Morgan Stanley in the structured investments space.

David: Yeah. Yeah. Well, what’s interesting is and and I remain, agnostic, to be truth be told, Lou. I’m independent, if you will, here as as Halo was, but Morgan Stanley’s capital markets team, you know, was just it’s there’s a pedigree that only, you know, a probably a hundred years plus, I I forget the, you know, that the you have to build over time, and it’s global. So break let break this down for me. Tell us about the adviser solutions team. Curious about this.

Lou: Yeah. Absolutely. Very excited about the adviser solutions team. How are we, connecting with? How are we partnering with? How are we strategizing with the independent RA space. And a couple of different ways that we’re able to do that right now has been vis a vis our thought leadership, trade ideas, in the structured investment space, making sure that we’re working hand in hand with the client, bringing them tactical, topical ideas that best fit their portfolio and, you know, their wealth management practice. And then alongside of that has been, a newly launched, strategy, which we’re considering to be the equity risk management suite and we are now offering that out to the independent RIA space as well.

David: Okay. So the so the the equity risk management components is interesting, obviously, because, equity risk is there’s never a time when it’s not important, but it’s certainly, we’re in a heightened state right now with the magnificent seven and all the the other, talks. So so this is a new strategy. Can you break down this a little bit deeper for us in terms of what what what do you get out of the s equity risk management component?

Lou: Absolutely. So to touch a little bit on the equity risk management suite of different type of strategies that we have. Right? We essentially will work. We strategize with the RIA. Right? And the beauty of it is we’re not never leading with product. We’re not leading with a trade idea. We wanna better understand kind of what the RIA is trying to solve for for their clients’ concentrated position. And that can be a couple of different things. Right?

David: Yeah. Obviously, with market trading at all times highs and, the techs the tech sector going to the moon. We’re hearing bubble talks again. But, you know, aside from the, the Hyperbowl, what is the RIA channel? You know, how what are they saying? What are you hearing out there? Because I know you travel a lot and you see a lot of different clients. Any trends or anything you’re seeing out there, you know, sort of on the front lines?

Lou: Yeah. Absolutely. Right? So a main sticking point, which is kind of a champagne prompt to have in this type of market environment, has been, you know, many of many of our RAs have come to us and essentially said, hey. I have this one specific client. They have a concentrated single stock position in their portfolio. Right? And, essentially, what that looks like or what that could be, right, is client could essentially inherit maybe a large concentrated position.

And then, of course, given the the run up in equity markets and in the tax base in particular, that position is now grown. Right? So in terms of terms of their weighting of their portfolio and how much concentration that position, actually makes up in the overall portfolio, It’s now become, you know, high end. So RA’s essentially wanna figure out a way, how can I mitigate this risk for the client?

Right? So that’s first and foremost. Two, they’re thinking about how can I mitigate this risk and also diversify my client’s position? Right? Similar to the rest of the portfolio, most RAs run a very diversified practice for their clients. They wanna figure out a way they could diversify this exposure for their client. Right? And then third to that is going to be, how can I do both of those things in a tax efficient manner?

David: Okay. Yeah. Well, enough of the the sweet the cupcake questions here, Lou. I’m gonna I’m gonna give you a tough one now. So, I’m more friends, but I, you know, I like to put you on the spot, and I know you’re a sharp sharp guy. So, obviously, you mentioned concentrated stock positions. It makes me think, obviously, of variable prepaid forwards. Can you give us a little bit more about the strategy, how Morgan Stanley treats variable prepaid forwards, or maybe even an example of, you know, like, if I was a hypothetical adviser and I came to you, how how would that what would this look like?

Lou: Yeah. Absolutely. Right. So based on a lot of feedback that we’ve been seeing, receiving from the RIA space. It’s it’s been extremely positive. Right? Because the variable pre pay forward in nature really does, solve for many of those different concerns and, you know, essentially voids that the the RA is trying to solve in the overall portfolio for their client. Let’s start with what is the variable prepaid forward essentially help the RA solve for for their specific client.

Right? So first, right, we had mentioned earlier the hedging aspect of it. Right? So if I have a client, and I’ll use a, an illustrated example here to kind of walk us through this. Let’s say I’m an RIA. I’m a financial adviser, and I have a client who has a hundred million dollars now worth of Apple single stock position. Okay. Now that’s just one position that sits in a portfolio amongst several other investments. Right? So right then and there, we’re gonna try and figure out how are we gonna diversify our exposure to Apple. Now your first the first thing that comes to mind would be to start selling out of the position. Right? We’re gonna lock in those gains for the client. They did a great job, great investment.

Now they’re going to start to sell out of the position in the open market. When they sell out of the position in the open market, what do they incur? They’re going to essentially incur taxes.

David: Yep. They’re everywhere.

Lou: Right? Yeah. Yes. They are. So they’ll still essentially incur taxes, right, on the sale of their stock. Now what the variable prepaid forward does, it essentially helps the client, and I’ll get to it, and we’ll break down each each component of it. Okay. It helps them essentially seek diversification, provide the capital preservation, help them in certain instances monetize their position in a very tax efficient manner.

David: Well, this, what’s interesting is, Lou, we we work we work with you guys. And, whether we come to you with a with a hundred thousand dollar problem or a hundred million dollar problem, you guys always you’re you’re always eager to help. Right? And so it’s, this isn’t so much a matter of size per se in terms of your guys’ team’s enthusiasm to help. But, like, let’s just say, what what does the target audience or candidate look like for something like this?

Lou: Yeah. Absolutely. So the let’s let’s separate those two questions into what does the target, audience look like. Right? So couple ways in which a client could actually, have this type of champagne problem of a concentrated single stock position in their portfolio. First and foremost, right, they might have been able to inherit the shares, right, vis a vis a trust or from, you know, a family member. Second to that, they could have been a long term employee with the company. Right? And throughout their, you know, long career, they continue to accumulate shares of the company that they worked for.

Another way that in which they could do that is, which has been very popular these days, you know, many many folks, especially on the West Coast. Right? They they are very passionate about starting their own business. They, you know, their business becomes very successful, and then, essentially, they go ahead and sell their business to a publicly traded company. Now on that sale, they usually get receive shares of that publicly traded stock’s name. So now they that’s another way that they can acquire, concentrated position as well.

And then third, I would say the last thing, right, which again, I would say has come after the math aftermath of maybe one of a couple of those different scenarios has essentially been that which may have started off as a smaller concentrated position. And then given the run up, right, in the equity markets, it’s now grown pretty robustly for the client.

David: So I gotta be honest, I’m thinking here. If I’m a creative financial adviser, RIA, and, I’m looking to do this on my own, like, how is is there any difference between, like, say, listed options I might be able to do this in the way which how you guys structure this?

Lou: Yeah. Absolutely. So let’s actually break down, the variable prepaid forward and discuss kind of the moving components of it and how they tie into a couple of those solve fours that I had spoke to earlier. Right? So the first one that I wanna speak to is the capital preservation.

Okay? So what Morgan Stanley does for the client is essentially we will provide a zero cost collar or a costless collar rather. Right? That’s essentially going to provide a level of protection for that client shares. Okay? And then, you know, in turn of that, they’re also going to be capped on their upside potential or the stock itself. Okay? So we’re essentially collaring the transaction. Now because their maximum loss is defined, right?

Morgan Stanley is willing and able to essentially provide, LTV or a lending component on the client’s max on on the client’s maximum loss on the position. Okay. So for example, right, we go back to the example I alluded to earlier, that a hundred million dollar Apple position. Let’s say, hypothetically speaking, Morgan Stanley would essentially layer on top of those shares, layer over, a costless collar for the client. Right? Let’s say the strike is at the upper call strike or the cap price is at one twenty. And let’s say that your floor price, right, or the put is struck at ninety. This means that the client’s maximum loss on Apple, as long as they have the this cost as collar strategy overlaying the position, it’s going to be ten percent. Okay?

Now because it’s defined and we know this, we’re willing to provide essentially LTV on that the remaining ninety percent of their position. And now that rate will be, you know, at the rate at which Morgan Stanley essentially borrows money as a bank. Right, how we actually fund our balance sheet, right, which is the Fed funds overnight rate, plus, you know, a spread, plus or minus a spread, and, essentially, we’ll lend that client at we’ll lend that, cash component out to the client. So now just right alone then and there, we have solved for two things for the client.

We’ve solved for the wealth preservation, and we’ve also solved for the monetization for that client as well. We just created a liquidity facility for that client with and I think what’s most intriguing about this is that the client has not had to sell their shares. They still retain the shares. They still retain dividends and voting rights. Their strategy just overlays their position.

And now the final component of it is going to be that cap price that I mentioned of one twenty. So let’s say, David, you and I entered into, this transaction today. And then the Apple stock continues to move in the right direction. Right? Apple continues to move up. As the stock continues to rise, right, and it starts approaching that cap, Morgan Stanley is actively monitoring, right, not managing, but monitoring the strategy for the client. And, essentially, as it starts to creep up towards that cap price, we are usually in active dialogue with the RIA, talking to them about what does it look like to reset their put, reset their call. Right? So resetting that floor strike, resetting that cap price for the client. And why are we doing that? It’s because we wanna provide a seamless experience for that for the client, and we want them to participate in the upward trajectory of the stock itself.

David: Yeah. What’s interesting there is that you could it sounds like you could retain ownership. And like you said, if you started a business or you spent considerable time somewhere, you’ve you’ve invested your life into a business, you can retain the ownership component, add the protection component, and still monetize in what it sounds like and rather in a in a in a very capital efficient way in in that the funding cost on something like this is has to be so much better than, say, if I went to a brokerage margin or so forth, and I’m talking about funding because, like so I gotta ask, how does Morgan Stanley make it so darn competitive in the first place?

Lou: Right. So we are a leader, right, in the in equity derivative space throughout global markets. Right? We are an industry leader there. So in terms of the collar itself, right, the options that comprise that collar, we are a leader in that space, and that’s how we’re able to provide competitive option pricing. Right? And then second to that, right, on that loan per on that loan portion of the variable prepaid forward, Oregon Stanley as an institution. Right?

How do we borrow money on a day on a daily basis in order to fund our balance sheet, to fund the rest of the businesses within global markets and other areas of the bank? We essentially borrow our money, right, at the Fed funds overnight rate. Right? So that’s why we’re able to also maintain a relatively tight spread when we essentially on that on that lending facility leg of the variable prepaid forward that we put that we provide for our clients. Basically, the strategy.

David: Yeah. Yeah. So if if my if I’m an adviser and my client wants to, put on an overlay, hedge and monetize a position, So I I gotta ask then. So, like, does the client keep the shares? How does ownership work or, say, dividends or maybe even voting rights?

Lou: Yeah. Absolutely. So, like, as mentioned earlier, those shares, right, are not sold. Those shares are not forfeited to Morgan Stanley. Those shares are pledged to Morgan Stanley, right, in order to enter into this strategy. Now whether you custody at a Schwab, Fidelity, Pershing, right, or even if you decide to custody here within global markets at Morgan Stanley, those shares become restricted.

So they become restricted from trading in and out of them because we have this variable prepaid forward strategy overlaying the position as a whole.

David: Okay. So if, if an adviser is interested, like, what’s the time frame in getting started on something like this, or is there, like, a minimum or maximum, size you would need to get started?

Lou: Right. So I’ll answer that in two ways. Right? So let’s discuss kind of timeline for onboarding.

I would say expect your timeline for the onboarding process, you know, and the due diligence process can can take anywhere between two and four weeks. Right? And there’s gonna be many different factors and components that factor into that. That’s gonna be the type of entity that actually owns the shares. Where are those shares currently custody today. And then, essentially, the diligence that Morgan Stanley provides on both the shares, the client owning those shares, as well as the RIA. So that’s kind of the onboarding. So you could expect two to four weeks on average for to actually start and execute the transaction.

Now from a shareholder criteria standpoint, right, here at Morgan Stanley, our hurdles are essentially, we’ll trade the aside the position size, okay, as low as one million dollars. That means if a client has one million dollars of Apple stock and would like to enter into a variable prepaid forward contract with Morgan Stanley, we would be willing to accommodate that. Okay. So now a second thing that that matters to that and the second area of criteria regarding the shareholder is going to be their liquid net worth.

Here at Morgan Stanley, we set that bar at ten million dollars of lick investable liquid investable assets. So that means if you have a client who has liquid investable assets of ten million dollars plus, they have a one million dollar Apple position, we’re more than happy to facilitate facilitate that for the client and overlay that strategy.

David: Okay, Lou. How if somebody if an adviser wants to hear more about this, how do they get in touch with you?

Lou: Absolutely. So through the strength in our partnership with Halo in the RIA space, if any RIA in out there listening to the podcast is interested in learning more about our full suite of equity risk management or in in particular variable prepaid forward, I would highly encourage them to reach out to their respective Salesforce coverage at Halo in order to set up a call with us. We’re more than happy to hop on, and kind of go through that education process for the client.

David: Alright. Well, thanks again for your time today, Lou. I look forward to, speaking with you again soon. We’ll have to grab a beer next time you’re in Chicago. Any, any any quick leave behind, sir? Any takeaway?

Lou: Yeah. Thanks, David. Yes. So quick takeaway, I would say, is if I’m an r if you’re an RIA listening into this podcast and you have a client with a concentrated single stock position, Right? And you’re thinking about different ways, unique ways that you can add value to your client and help mediate a potential problem that they have with the portfolio. Right? Think about how am I going to help the client diversify out of the position? How am I going to, most importantly, help them lock in their gains and preserve their capital?

And if you’re interested in potentially helping them monetize on their position as well without giving up ownership of the shares and selling out of those shares in a tax efficient manner, I would say reach out to you again, reach out to your your Halo Sales representative. Have them let them know that you wanna learn more about Morgan Stanley’s equity risk management suite and, in particular, variable prepaid forwards. And we’re more than happy to hop on a call with you to kinda discuss strategy, and educate you, you know, a little bit more on kinda how their strategy totally unfolds, different scenarios, and how Morgan Stanley monitors these strategies for the RIA space as a whole.

David: Great. Alright, Lou. Thanks again for your time today, and we, we look forward to speaking with you again soon.

Lou: Likewise. Thanks, David.