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What's the Alternative? | Episode 26 | Riffing on Returns: A Structured Note Playbook with Vinay Tolia
27 Plays1 day ago
Join Shana Orczyk Sissel, founder and CEO of Banríon Capital Management, as she discusses the ins and outs of structured notes and buffer funds with Vinay Tolia, CEO of Marine Layer Advisors. In this episode of 'What's the Alternative Podcast,' learn about the growing trend of defined outcome vehicles in the investment space, including their complexities, risks, and proper uses. Discover how Vinay's background as a derivatives trader provides unique insights into optimizing structured notes for clients, and why younger advisors might have a different view on these products compared to older generations. This episode is a must-watch for advisors looking to understand the nuances of structured notes and buffer funds to better serve their clients. –
Key Takeaways:
- The evolution and efficiency improvements in structured notes and buffer funds.
- Key differences between calendar offerings and custom offerings.
- Important questions advisors should ask when considering structured products.
- The impact of leverage and understanding risk in defined outcome investing.
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Transcript
00:00:00
Speaker
Bitcoin for three years and your max return is 45%.
Introduction to Bitcoin and Alternative Investments
00:00:03
Speaker
Like, why would you do that? Like that doesn't, to your point, the whole, you're not putting in Bitcoin to be your stable, give me give me 8% a year type thing. Like you're putting your, you're putting your money in Bitcoin for this thing to triple in three years or potentially down 80%, right?
00:00:19
Speaker
That's the whole point. Yeah.
Host and Guest Introductions
00:00:26
Speaker
Hello everyone. My name is Shana Orzak-Sysel and I'm the founder and CEO of Boundary and Capital Management. This is What's the Alternative podcast where we get into the weeds of alternative investing with the leading experts in the space.
00:00:41
Speaker
Today we have Vinay Tolia with us. Vinay is the CEO of Marine Layer Advisors. He grew up in Michigan and entered finance directly out of college. His first internship was on the trading floor of the CBOE.
00:00:56
Speaker
and later he co-founded a derivatives trading hedge fund with his twin brother, which ran for almost 20 years. After a brief stint taking a company public in Canada, Vinay is back in finance.
Structured Notes Overview
00:01:07
Speaker
Realizing that REAs do not have the institutional derivatives trading knowledge needed to best trade structured notes, he co-founded Marine Lair with his brother Sanjay.
00:01:18
Speaker
They now operate as a derivatives trading desk for independent REAs, taking the guesswork and administrative hassles out of structured notes. think this is a pretty timely conversation to be had as structured notes and buffer funds and all of these, um they what are they? um um known outcome or defined outcome. There you go. Defined outcome vehicles are quite popular and more and more are coming out.
00:01:46
Speaker
The latest trend in defined outcome is with crypto. Vinay and I have talked a lot about this. We both have very strong opinions. And I think anyone who's seen me speak on TV knows that I have been very, very vocal about my disdain for some of these products.
Marketing and Misconceptions of Structured Products
00:02:06
Speaker
And it's not the product itself that's the issue. It's oftentimes ah the marketing and the ah the pushing of product that fits the niche, but maybe isn't the best product for the niche. There is a time and a place for structured product. There is a time and a place for these defined outcome vehicles.
00:02:24
Speaker
But the way that the industry has kind of exploded in the space is concerning. So ah it thought it would be great to have Vinay on with us because he shares some of my thoughts here and we can dive deep into structured notes.
00:02:39
Speaker
But I think a good place to start for our audience, Vinay, is to kind of talk about a What is a structured note? B, yeah how does that connect with buffer funds?
00:02:50
Speaker
Because I talk about them interchangeably for a reason. And then sort of what you you've learned through your years as a derivatives trader um on how these things have been traditionally structured and and sort of you know the pros and cons.
00:03:07
Speaker
Yeah, well, first, thanks for having me, Shane. I'm excited to speak with you and and get deep into all this stuff. And it's always ah nice to have someone who is kind of a ah derivatives nerd like myself.
00:03:20
Speaker
So ah yeah, so they let me let me just back up. So I... I traded derivatives, listed derivatives for years, and I heard all the things about structured notes that most people hear that, hey, they're super high fee product, they're rip offs.
00:03:37
Speaker
um And all the negative things that you hear that it's just a bunch of BS that the bank is trying to ah you know shove on to retail. And that was my kind of very uneducated opinion on the space for years.
00:03:55
Speaker
where What really kind of flipped the switch for me is i didn't realize how much more efficient these things have gotten over the last five or six years with the advent of um a lot of the platforms that allow for greater distribution and for you know allow allow auctions to take place. And what I mean by auction is for the longest time,
00:04:16
Speaker
um You know, if you were a these things were only available to people who are clients of the large private banks, and they could only deal with that bank's trading desk. So if you were a JP Morgan customer, you got access to JP Morgan structured notes, and that's it.
Efficiency and Accessibility of Structured Notes
00:04:33
Speaker
ah Now you can run an auction and so you can you can get a note from any bank, whether it be JP Morgan, Morgan Stanley, or you name it. um And that that has caused this kind of industry to get much more efficient. This is like you know, it reminds me of being back in the trading floors when it was when it was an actual floor and we were trading in fractions and now things are, they're still kind of archaic, but they're moving more towards the more efficient markets of today.
00:05:02
Speaker
so that's that That was kind of ah you know how I, will the big unlock for me was i realized that, okay, these things have gotten more efficient and I realized, hey, I should be doing this myself in my own personal account.
00:05:15
Speaker
And i took that realization, started talking to some RIAs and realized that the way they were looking at these products was not from a derivatives first approach.
00:05:25
Speaker
And to answer your other questions, what is the structure note? The structure note is kind of a prepackaged product bond and derivative. So it, it gives a you know, you use the term defined outcome, which I like, um because you invest in a product, it's essentially a corporate bond.
00:05:44
Speaker
And at the end of the, you know, at the maturity date, for the particular note, there is a return based on like you know specific levels of an index or some kind of underlying. That's why they call it defined outcome. you just You know that if the S&P is above this or below this, you know exactly what you're going to get.
00:06:06
Speaker
And the way these things are created is with derivatives. And so the best way to understand if you're getting something that makes sense for your client or is pricing well is to understand derivatives. But the vast majority of people who ah trade these things and who sell these things do not understand
Historical Context and Complexity of Structured Notes
00:06:26
Speaker
derivatives. So they end up giving advisors a lot of things that don't make a lot of sense for their clients, which I'm happy to get into, but I know i'm I'm droning on, so I'll stop right there.
00:06:38
Speaker
No, I think that's a really good point. you know When I started seeing structured notes out in the marketplace, it was 2007, 2008. It was, as you said, coming from the big investment banks.
00:06:51
Speaker
um It was broadly available, um so I didn't have to be a JPMorgan or a UBS agent. client to gain access to them. They were distributing them broadly speaking because I was working for an independent REA at the time.
00:07:04
Speaker
But the one thing that always struck me was that I was captive to whoever the issuer was. So if UBS was the issuer of the note and I needed liquidity, which at that time, a lot of people were you know panicking and wanting to sell out of things.
00:07:19
Speaker
I had to go back to UBS and UBS had all the power in the world to give me as a distressed seller, you know not the best pricing. And I had no choice but to accept it if I wanted liquidity, because that was my only option.
00:07:34
Speaker
um The other thing is exactly what you were talking about. I don't know that people fully understand or appreciate that At its core, and I'm probably oversimplifying this a little bit, a structured note is simply a zero coupon bond paired with a derivative contract of some time, a call option, a put option, a combination of those two things. But that that's what it is.
00:07:59
Speaker
They have stated expiration dates and stated maturity dates. And they're also an option contract that when they are in the money and they are executed, that's it.
00:08:12
Speaker
There's no second bite at the apple. And so i think a lot of folks don't fully appreciate that aspect. I do think it's a little easier to understand and swallow in the structured note aspect when it's packaged as a structured note.
00:08:27
Speaker
But I think in the buffer ETF, wrapper, it's not as well understood. It's not fully appreciated that this is a you know buy at the issuance, sell you know sell out of it at the maturity, or actually you just get exercised out of it at the maturity, it just ends.
00:08:46
Speaker
um And then everything in between is kind of the wild, wild west. And if you get in at any point in between, you're not actually guaranteed
Crypto Products and Structured Notes Comparisons
00:08:55
Speaker
the defined outcome. But more importantly, you don't understand that this is an option contract, a derivative with a zero, you don't understand that it's a single round trip.
00:09:06
Speaker
So a lot of the crypto buffer stuff that's coming out and crypto being as volatile as it is um concerns me because if you're getting downside protection of like zero downside or yeah zero or 20% cap on downside, crypto can and has had more than a 20% round trip in a one year period of time.
00:09:29
Speaker
It's the first 20% that you're protected on. After that, it's either these buffer funds aren't like structured notes where you're just exercised out of it and you're done. The buffer products continue till their stated expiration date, but the products underneath it don't exist anymore. It's just really the zero coupon at that point. And you don't have the protection of the downside anymore. It was a single trip um because they're they can't rebuy option contracts in the way that these buffer funds are built. Are you speaking of buffer funds or the ETFs?
00:10:01
Speaker
Well, I mean, the ETFs are the funds. that Yeah, got it. So they just they just automatically roll after. Yeah. They do, but um unlike a traditional structured note where once the event happens, the notes you know matured um and and you move on, um and the buffer ETFs don't work that way. And I don't know that everybody is fully aware of that.
00:10:23
Speaker
um So we can dive into that a little bit, but let's talk a little bit about, you know, a lot of advisors love these products because they are defined outcomes and for risk-averse clients, being able to give them, you know, exposure with training wheels or exposure with like a parachute.
00:10:43
Speaker
to areas of the market that they might not have the stomach to to take the risk of seems like a good idea. And in some cases it can be, but let's talk a little bit about like the broad availability of structured notes versus what you guys are doing, which is creating custom notes, you know, based on individuals needs and and kind of how those two things are different and, you know, the pros and cons of each.
Custom vs. Broad Offerings in Structured Notes
00:11:07
Speaker
Sure. So just let me take my glasses off. I can see the reflection here. um jiy ah you you You did not oversimplify it. You hit it right on. side That's exactly what a structure node is.
00:11:18
Speaker
It's a zero coupon bond and some kind of package of derivatives. And the zero coupon bond is easy to understand everyone gets the zero coupon bond um but the derivatives are harder to understand and they're harder to value so like to figure out what's what makes sense and what doesn't you have to understand the derivatives so let's let's talk about a little bit about um you know the broad availability of structured notes as in you know, the issuance that are coming out, um you talk about marketplaces or you know, UBS or one of the big investment banks issuing like broadly to the market, structured note versus kind of what you're doing. And there are other platforms that do it. um Yeah, yeah, yeah. Kind of the pros and cons of each.
00:12:03
Speaker
Yep. So a couple of things. One is one of the reasons these things have been gaining in popularity and um is it is, you know, as you very well know, ah advisors are always, especially these days, trying to differentiate, right? Like, you you know, clients are asking, hey, what am I paying you 100 bips for if you're just running a robo portfolio for me?
00:12:31
Speaker
Structure notes are one of the things that they still can't do themselves. So like they have to go through an advisor. um There's a handful of these things, not the only thing, but that that has been a reason why, you know, if you want to get people uncorrelated, differentiated returns, they have to go through an advisor to use these.
00:12:51
Speaker
Now, I think what you're referring to is the difference between calendar offerings and custom offerings. So every month, the big banks will issue just a... I just want to let our audience know my cat decided to make an appearance.
00:13:05
Speaker
i think my My dog is pawing at the door over there. So if you if you hear any whining, that's what that's what's going on. ah So cute. the It's okay. As you were saying, calendar offerings and customer offerings. Yes, yes, yes. So every month, all the big issuers, UBS, JP Morgan, you name it, they issue a whole array of notes that are open for the entire month.
00:13:29
Speaker
So they give you a price of a note, and it's open for the entire month, and advisors can put in any amount they want. They can put in as little as $5,000, or they can do as as they want. do as much as they want Now, the problem is, you know, if you just think of take a step back and think about this, if you are a trader and I was asking you to make a price for a product that you have to honor for a whole month, you're not going to make me a great price. And understandably, because you don't know what's going to happen over the next month.
00:13:59
Speaker
So these calendar offerings are, the you know, they're not the best price. They're they're very wide, wide kind bid-ass spread. um And so for, you know, what what we do is we kind of work with our clients and figure out, first of all, what is the right structure? What are the right underlyings? How much protection do you need? All that, all that stuff.
00:14:24
Speaker
And then we trade a custom note. So we trade a note that will trade in a couple of days to a week from when we talk to the bank. And what that does is it gets you a much better price.
00:14:36
Speaker
So, you know, a big part of, um I mean, this is low hanging fruit that everyone knows, but ah a big part of structured note users are just moving from calendar offerings to custom offerings.
00:14:48
Speaker
And you get much better pricing just by doing that because you're getting something bespoke to you and not something that the bank is holding open for a ah prolonged period of time.
Buffer ETFs and Usage in Portfolios
00:15:00
Speaker
So let's talk a little bit about how buffer funds are often associated and mixed in with this conversation um and why are there similar uh but also why they're different so you know buffer ets have absolutely exploded as you as everyone knows and i believe that the one of the main reasons for that is just the simplicity of it it's like a lot of these guys that i know that use them they know that it's not the optimal thing um if you especially especially if you're buying and holding if it's if it's if you want to
00:15:41
Speaker
you know, park cash somewhere for a little bit. I understand why, you know, you use a buffer ETF. If you're talking about holding something for a handful of years, which I've seen multiple people do it you know, it, it's a high fee product.
00:15:57
Speaker
ah You have that upside cap, which, as yeah as we know, markets don't just, ah you know, on average, they might, you know, they go up, eight, nine, 10% on average, but that's not how they actually move. Like there you got a 5% up 30 and then ah flat, right? And so ah when when you have the big market rips, if you're capped at 11, 10, 12%, you're not getting all that juice where if you were if you' were going to put it into if you were to take that money and put it into a structured note that matures in three, four, five years, you get you have uncapped upside. So
00:16:36
Speaker
But for ETFs, there's a time and a place for them. I'm not here to knock them. I think they're really you they're they're great products. It's just that i've I have found that lots of people use them simply because of the ease and the fact that it's an ETF so they can plug it into their existing portfolio management software, whereas structured notes are a little more cumbersome to administer.
00:17:00
Speaker
And that's actually one of the things that we that we try to solve. So, yes. i have been ah much more vocal about my disdain for Buffer Funds, but some of the reasons why i dislike Buffer Funds are for some of the things that you discussed. I just, I don't think they're used properly, I don't think they're used optimally, and I do think that they're not communicated ah to the client properly. And for all of those reasons, I'm not the biggest fan. I also don't like some of the newer products that are coming out, which are doing buffers on products
00:17:35
Speaker
that the whole advantage of those products are the volatility and the ah the um asymmetrical return profile. um And when you remove that, which is what you do in these buffer products,
00:17:48
Speaker
it there's no purpose you know i i saw one yesterday sorry to interrupt i saw one yesterday on bitcoin on you know an ibit the etf and it was three-year it was a three-year thing this is a structured note okay so it did not buffery but like 20 buffer but it was and it had but it was and it had 200% leverage to the upside, but it was, it had a max return of 45%. And I'm thinking like over three years, Bitcoin for three years and your max return is 45%. Like, why would you do that?
00:18:19
Speaker
Like that doesn't, to your point, the whole, you're not putting in Bitcoin to be your stable, give me give me 8% a year type thing. It's like, you're putting your, you're putting your money in Bitcoin for this thing to triple in three years or potentially be down 80%, Like that's,
00:18:35
Speaker
That's the whole point. Yeah, there's um the latest trend and most of the new offerings in the buffer space have been crypto related, either attached to Bitcoin or ETH. um And I am in full agreement with you. um The first ones were like 0% downside, but like ah upside cap of like 10%, which is ridiculous.
00:18:54
Speaker
Now they've done what you're talking about, which is having a little bit of a longer period of time, but like your upside is capped at 20 or 30 percent and your downside is capped at like 20. And ah my whole point is exactly what you just said. The reason you own Bitcoin is because of the asymmetrical return opportunity um and also the knowledge and understanding that, you know, it's volatile and you could be down 80 percent as much as you could be up a thousand percent.
00:19:22
Speaker
um But that has diversification benefits in a portfolio. um And so you want that. That's that's that's that's a feature, not a bug. um And so when you remove that, it feels a little bit disingenuous to have these products because the folks that are buying them would never really own Bitcoin.
00:19:42
Speaker
Because they're risk averse. So they're buying them to say they own Bitcoin, but it's not really Bitcoin exposure. I totally um imagine having a venture capital portfolio where you cap your winners at 45% over three years. Like that's insane. the whole The whole point of that business is to have, you know, two out of a hundred that are a thousand X. So yeah, i I completely agree with you that that doesn't make a whole lot of sense.
00:20:11
Speaker
Yeah, so now that we've established that some of these products, I like to say, because I'm not afraid to make waves, they're just real package marketing stories.
00:20:21
Speaker
um And they just don't make sense in my head. um you know Some people are more aggressive about it. Cliff Aspenis has written many a white paper on his disdain for these buffer products. um But ultimately, at the end of the day, ah buffer ETF is a structured note in an ETF form. And you have to understand that, look through the perspectives, understand what the underlying are, how it's being priced, but also understand that the ETF's pricing and all the price movement between the issuance and the expiration of that buffer before it rolls is going to be market movements and and whatever the underlying is doing.
00:20:59
Speaker
um is going to be reflected in the price of the product and not necessarily the defined outcome that you purchased it for. And so that's a conversation you need to be able to have when your client sees their statement.
00:21:11
Speaker
um It's a little bit different in the structured note format. And why don't you talk about operationally kind of how it works? um Because you did note that one of the reasons that you think buffer funds have been so popular is because they're not as operationally cumbersome.
00:21:27
Speaker
you know When an advisor is considering these defined outcome products, what should they be considering? And I've always found that it's never that the operational issues are so cumbersome that you can't get over them.
00:21:41
Speaker
It's just if you don't know they're coming and you're not prepared for them, they can immediately stop you from proceeding and then deciding to do the path of least resistance. But if you tell them ahead of time, look, this is what's involved, they can be prepared for it and work through it. So I think that that's a good opportunity to do just that.
00:22:01
Speaker
Yeah, so, great question. So one of the things that we see is that, so the, you know, we're talking about the most simple kind of form of structured notes was just a single index. And, you know, if it goes up, it's capped at a certain point, if it goes down, you're exposed to losses after a certain point.
00:22:21
Speaker
these things get much more like you can you can do anything you want with these things. And that's really good. And it's but it's also really scary for a lot of people like, you know, most people don't want to and they all have different names. Phoenix Auto Call and Catapult and, you know, Shark Fin and people people start seeing all these things and they just say, you know, I don't want any part of this. Let me just go on to you know whatever I was doing before.
00:22:47
Speaker
um But like, but so a lot of people are scared away by the complexity and I totally understand. um The, you know, they're typically a way an advisor allocates a portfolio of equities is by using a portfolio management software and Those things all look at listed ah equities and you can just you can plug in any of those things into your portfolio management software.
00:23:16
Speaker
Now, I don't know how good they model buffer ETFs, but it it is a listed equity so you can put it in there and it'll it'll it'll feed through and look at all your, you know analyze it in ah context with all your other equities.
00:23:30
Speaker
Now, it is difficult to do buffer ETFs because they typically have no history. And they typically don't have more than a year's worth of performance, um and then they're just done.
00:23:42
Speaker
And so and putting them in any kind of analysis becomes exceedingly difficult. um But in statements, that's a different story. um And so that's kind of the thought process. But if you were going to model out something like this and you knew what the underlying was, which I would assume would be the case in some of the structured products that you talk about,
00:24:02
Speaker
then it's a little easier to model it because whatever the underlying is of your structured note is usually a publicly traded instrument or an instrument in which you can easily model it out with some other proxy, correct?
00:24:14
Speaker
For sure, for sure. um That gets a little more complicated that when you have multiple underliers on on a particular note because you don't know exactly what you have exposure to until you know later on in the duration of the note.
00:24:28
Speaker
But the big difference when it comes to ah administrative stuff is with the listed equity, if you, you know, However you wanted to rejigger your clients portfolios, like if you if you wanted to and making this up, if you if you wanted to sell everyone's Tesla and replace it with a buffer ETF, you could do that with a couple clicks with the portfolio management tool.
00:24:52
Speaker
Can't do that with a structured note because these things are ah essentially corporate bonds. So you can't just point and click and and trade it the way you trade in equity.
00:25:04
Speaker
And so what we find is a lot of people really like these things and they start and they start putting them in client accounts and they start allocating kind of sleeves of their of their client portfolios in these things but then what ends up happening is you have new money coming in and out and you have all these different notes that you're trading every single month or quarter however often you have them and you can't just point and click and rejigger them the way you can with ah listed equities.
00:25:32
Speaker
And so you need some help. And what what a lot of people, what ends up happening is you end up with these unruly spreadsheets and you have a junior person whose job is like 80% of their job is basically managing this spreadsheet.
00:25:46
Speaker
And you might say like, This sounds insane and yes it is, but like these people love the features of the structured notes so much that it makes sense for them to have a junior person do nothing but rejiggering spreadsheets all the time.
00:26:00
Speaker
um And that's where we come in. We have software that analyzes across customer accounts exactly how the customer wants it so that to get you out of these spreadsheets and however often you want to rebalance your portfolio monthly, quarterly, whatever,
00:26:15
Speaker
We just have clean reports for you um to kind of try to try to we call it Q-SIP sprawl because each one of these things has a different Q-SIP. And before you know it, you have hundreds of Q-SIPs in your client accounts and it gets really, really hard to track.
00:26:32
Speaker
If that makes sense. So what prevents a firm like yours, and maybe you already do this, or maybe this is in your future, of ye ah approaching structured product the way that a lot of folks approach like municipal bond laddering, or you know um you get these SMAs where they're doing laddered investment grade bonds.
00:26:52
Speaker
um You see it a lot where you can just buy the SMA, they build out the ladder for you, and then they just manage the trading for you and you're just making allocations into the SMA.
00:27:04
Speaker
um Is that something that you think is in the future for the structured note we are industry? were Yeah, so that we're we're actually in the process of rolling that out right now. um We're in the process of rolling out that's absolutely one of the solutions.
00:27:18
Speaker
um But there's a lot of managers, there's a lot of advisors who don't like using SMAs, right? There's a lot of advisors who who say, hey, the client's paying me for my, like I consider myself kind of a a ah PM and the client's paying me for my advice.
00:27:35
Speaker
So I don't want to outsource that, have another layer of fees. So that's why I'm doing this myself. So what What we try to do is for those folks who want to do it themselves is to take away that administrative hassle.
00:27:49
Speaker
That's ah that's like a big part of what we try to do. Well, will say to those advisors that feel that way, um institutions outsource this stuff for a reason. ah Your job as a portfolio manager and an advisor is to you know make the right decisions for yourself and your clients and not spend more money. and but And I also like to point out the potential for error in the managing it yourself when it's this kind of complexity and this kind of approach is significant.
00:28:20
Speaker
um And it's like anything, you know, paying somebody who can do it better. That is actually the value you're bringing because your client can't get access to these A without you, but B,
00:28:32
Speaker
They can't get access to the people that you are outsourcing to without you either. And so you're actually earning your fee and probably more so than the potential for trying to do it yourself and screwing it up.
00:28:44
Speaker
But i go I'll get off my high horse on that one um because I feel like sometimes advisors are so concerned about earning their fee, they forget that earning their fee means also making you know smart allocation decisions and keeping themselves out of the um crosshairs of the regulators.
00:29:00
Speaker
um you know, you want your business to continue and you want happy clients. And the more you try to take on yourself when you're not the expert, the more likely you are to end up in hot water.
00:29:10
Speaker
So talk a little bit about, you know, how you go about doing what you do. you know We've talked about how most folks are doing the calendar offerings or seeing what UBS or JP Morgan is, but there are platforms like yours that exist that can assist in in finding these custom product offerings.
00:29:30
Speaker
Sitting down with the client, again, if we're gonna get to like earning your fee, This is a customized solution. You're sitting down with the advisor and their client and you're figuring out, you know, what the defined outcome is that the client needs, what the client's risk tolerance is and how to properly put that together in a product that makes sense. And then also you've pointed out ah several times already, you know, the duration of these things matters too. And so you're also figuring out, you know, what kind of duration makes sense.
00:29:59
Speaker
So what's it look like to work with a firm like yours? What is that, you know, look like as as what's that process for the advisor? So I'll note there there are of course other people who do what we're doing, but none of them are derivatives traders. Like there are some, there are people there who, there are some, clearly there's smart and talented people and they, ah some of them understand derivatives, but none of them are like, you know, come from the derivatives world. And like, that was the unlock for for me
00:30:34
Speaker
is when, you know, the the way we started this is we were talking to RIA friends of ours who were showing us products saying, hey, what do you think about this? And we'd look at this and say, this doesn't make any sense. Why would you do this?
00:30:47
Speaker
And because if you dig deeper into the terms, um You know, a lot of these things, and I'm sure you have railed about this in the past. A lot of these things, they, they hide complexity in the terms and you need to understand derivatives to know where you're getting ripped off.
00:31:04
Speaker
And I cannot tell you how many times I'll look at a client's portfolio and i mean, I'll, I'll say it very nicely, but we're like, like, how did this end up in here? Like, this doesn't make any sense.
00:31:16
Speaker
And so Okay, so that's, I'll get off my high horse too for a second. so like that's that's one of the things that's one of the things that makes working with us different is we'll flat out tell you, okay, so one thing, we're completely independent.
00:31:30
Speaker
Okay, a lot of the other big guys, they have um they have really murky fee structure. They have ah conflicts because a lot of the issuers are either investors in their platforms or they have preferential,
00:31:44
Speaker
ah you know they have preferential deals with a lot of these issuers. So like they're they're more incented to push product from a particular bank and not another one. We're totally independent. it doesn't matter if you trade with the tiniest bank in South America with us or you trade with you know ah Bank of America. doesn't matter. We get we get we get paid the same amount.
00:32:07
Speaker
So that that's one difference. And then what we'll do is we will sit down with you, ah the advisor, will figure out what it is that you're trying to do. Because typically what what happens is the advisor has something in their head that they're trying to accomplish, but they haven't sat down and figured out like, hey, what is my strategy around doing this? like i a lot of the a lot of people use these things for income, right? For yield.
00:32:32
Speaker
And a lot of advisors just say, okay, i'm i'm um'm I want a high yield sleeve. And so that this is what I'm doing. And they have they have a strategy, but it's somewhat in their head and it's not systematized.
00:32:45
Speaker
We'll sit down with them and help tease out what is it that they're trying to do. And we'll just help help you modify it. Like you you talk about laddering. We do that all the time. We make we try to make sure that advisors aren don't have a lot of note maturities at one time so that you know if you do get a market downdraft, you're not exposed to lots of principal loss in a particular quarter or month.
00:33:11
Speaker
um And then a lot of times, he's the advisors, they're not familiar with the you know some of the more efficient structures because they get confusing. So like we've we've had advisors who we've had switch into different products they've never heard of because frankly they they didn't even know they existed and nobody's taken the time to sit down and explain this to them in ways they can understand, right?
00:33:35
Speaker
The banks issue all these like pricing statements and supplements and all that, but it's really confusing and the advisor has much better things to do in their day than to sit there and look through the fine print on, you know, how ah ah the difference between a European and American knock-in option, right? So,
00:33:52
Speaker
um and so So working with us, we'll sit there, we'll we'll sit down with you. figure out exactly what it is you're trying to accomplish. And then we'll start giving you suggestions on, hey, this is this is what we think you should do.
00:34:05
Speaker
And then we have we have the platform and technology backend, same as everyone else. So if you want to do you know portfolio analysis and all that all that table stake stuff, we have it.
00:34:17
Speaker
But it's really that kind of white glove service to figure out what it is you're trying to do and systematize that. that's That's what we're different. You're taking me back and flashing back to my days of studying for the KIA and CFA and the seven when you're talking about American versus European options.
00:34:32
Speaker
Nobody talks about that anymore. We just say options like everybody. Oh, it's a call option. No one ever it takes the time to be like, no, it's an American call option or it's a European call option, which is actually an important piece of information um that I almost forgot existed. So.
00:34:49
Speaker
Thank you for that. um But your point is a good one. you know Actually, everything you're saying is something that's true with Bonrian, the independence and not having a um the the incentives misaligned and things of that nature.
00:35:03
Speaker
And I think that's really important in order for the advisor to be successful and understand that. You also talked a little bit about like, it's all buried in the terms. I really do want to kind of hit that part home.
00:35:16
Speaker
You know, when i talk to anybody, whether it's with you know, any kind of ETF using a derivative contract or a buffer fund or a structured note, I really do encourage them to like read through the terms on the structures and the risks associated with it.
00:35:33
Speaker
Yes, there's a lot of legalese in here because the the issuer is trying to cover their butt in case something goes wrong in the worst case scenario. But it's important to understand some of that nuance and what are the things that you typically see in the term structure?
00:35:49
Speaker
um Maybe some key terms or key aspects of the terms um that you can kind of share with us so that the next time an advisor is doing this and considering it, they know what to look for.
00:36:05
Speaker
Sure. So that is a that's a that's a tough one because it's like it's constantly changing these. ah the The banks are to their credit. They're they're coming up with new products all the time.
00:36:16
Speaker
um Some of them are actually good products. Some of them are, you know, in my opinion, not not suited for every terrible products. Yeah. And yeah so you you like you really have to take the other side and figure out, hey, why?
00:36:30
Speaker
Why does the why do these things exist? I'll I'll give you a perfect example of one. so uh recently the last few years people have been get people have been showing um you know growth so growth notes are those those are the notes that are tied to equity. So like you typically do that if you're if you want S&P exposure or NASDAQ exposure something like that. And so you what you get what's called upside participation. So you like how much if the S&P goes up over the course of the the note, over the course of the note, how much how much of that upside you capture?
00:37:04
Speaker
And you obviously want as much upside leverage as possible. and so let's just for example let's for argument's sake say three-year uh uncapped note of the s and p has 110 upside participation so what what has started coming out is people doing ah notes on the spx fp which is s and p futures exchange of the the futures products so talking an option on an option right because the future being an option which inherently gets more complicated
00:37:38
Speaker
And with that, you can get when the when the s SPX is has 110% upside participation, the SPX FP might have 180% participation.
00:37:51
Speaker
So a lot of a lot of people say, wow, this is like, why would ever do the s SPX? This one has way more upside. But what they don't realize that Now that you're trading a futures index, you're making an inherent bet on interest rates as well.
00:38:09
Speaker
So futures, which without without getting too complicated, like, you know, the futures have a role. So like every few months you're rolling to the to the to the new future and those have embedded interest rates in them.
00:38:21
Speaker
So To trade SPXFP, again, I'm not saying you shouldn't do it, but you're now you're not it's not just a bet on the S&P anymore. You're making a bet on the S&P and interest rates.
00:38:33
Speaker
And I cannot tell you how many people we've talked out of this, or or at least like they were like, oh, thank you for explaining this to me because I thought this was a no-brainer. I got one where I get 180% upside and one where I'm getting 110.
00:38:45
Speaker
Why would I ever take the 110? Well, that's because you know there those are almost like you need to even be equivalent of the upside because you have this embedded interest cost and role feature and it so that's just a simple example um yeah kind of it's almost like you know we we like to send we tell people just anytime you see something that looks too good to be true just send it to us and we'll we'll exam we'll tell you like hey again we won't tell you not to do it we'll just tell you these are these are the these are the you know the the things you should take into consideration right because
00:39:24
Speaker
none of this stuff this None of this stuff is risk free. like i i get this all the time where where I explain these products to people and they're like, oh my God, this sounds too good to be true. I'm like, well, no, your're it it has it has risks in it, right? Like you're taking on counterparty risk now. You're not just betting, you don't have the S&P, you're losing dividends. um It's obviously less liquid, as you mentioned yeah before.
00:39:48
Speaker
so It's our job to make sure that you're getting compensated for that risk. Like that's that's what this is all about. i always like to remind people, um you know, if you think about what happened during the financial crisis and like who were hurt the most. Right. Because a lot of that was fixed income and credit based. But like the the people who ended up in the most hurt were the people that had the derivative on top of the derivative on top of the derivative. So you had your MBS, your mortgage backed securities, and then you had your CMOs.
00:40:16
Speaker
which are your collateralized mortgage-backed obligations, which is like a derivative of the MBS. And then there were derivatives on top of that. And then you can trade derivatives on these products. And once you start getting further away from like the actual product that your everything's being built on top of, you are introducing a new layer of risk because now you have multiple counterparties and multiple different risks associated with the new structure.
00:40:44
Speaker
And I think that it's a good reminder that as you get further away from the underlying in the derivative structure, you are inherently bringing on more risks and the risks become more and more opaque. And so you got to be really careful with that. I also you mentioned leverage, and I think this is an important conversation.
00:41:05
Speaker
I talked about this recently on a show called ATF Battles that I participated as a judge and We talked about leverage and leverage means a lot of things, right? Leverage can be derivative induced leverage, which is using a derivative to your point to amplify ah potential outcomes. But the risks associated with that kind of leverage are different than like the leverage of I have a portfolio of stocks.
00:41:32
Speaker
I am getting 8% off. I can borrow against that portfolio and my rate on the the the the borrowing is 2% and then I can magnify the 8%. It's a different form of leverage and it's a different risk profile.
00:41:48
Speaker
And there's, depending on the type of leverage you choose to use, you could be adding substantially more risk in, into the mix. When you talk about leverage and structured notes, can you talk a little bit about the different flavors of leverage and like yeah how to address the different risks that come with those different flavors?
00:42:10
Speaker
Yeah, I'm glad you read. Thanks for bringing that up I, cause you know, and I'm sometimes I shouldn't have used that word leverage. Cause that implies what you're saying. Like you're borrowing against something and you have, you know, way more capital at risk. So, well, yeah, so so you, you,
00:42:27
Speaker
what What I was referring to there is um is participation. You're talking about like you know ah how much... how much the the The point of using options is to either reduce risk or to amplify gains.
00:42:44
Speaker
like In a nutshell, that's that that is the point of options where where you're amplifying gains where you have a limited downside. right When you buy a call option, the most you can lose is the price of that you paid for that call option.
00:42:59
Speaker
So um that's what I meant by leverage is like, if you buy lots of call options, you know, you have upside leverage, meaning if, if, if something, if you buy a bunch of spy call options, the market goes up, you know, you, you have, you, you make a lot more than, than what you put in.
00:43:16
Speaker
um But, but you're still limited with your downside. So, Yeah, but the opposite is true too. If you're selling an option contract, then you have unlimited downside. That is also leverage.
00:43:28
Speaker
And that's exactly the point I'm trying to make. Leverage is all different things. But in essence, you use leverage because you think you can get a better return than cost ah of the leverage itself.
00:43:44
Speaker
um But you have to understand, is your leverage capped downside or is it not capped? Is it capped upside? you And you really need to understand the underlying as it relates to that.
00:43:55
Speaker
correct and and these structure notes use all different forms of leverage they they do but they also like they they they're not unlimited lost products it's not like selling a naked call option right where you can theoretically lose infinity right and these these you can only lose what you put into this to the to the structure product so it is it is different than you know listed options in that way but yes you're you're completely right that there people truly need to understand ah truly need to understand you know what is their risk to the downside and frankly, the the tax consequences of it too.
00:44:33
Speaker
ah Because sometimes if you have a product that's fully principally protected, um you have to pay phantom income income tax on it ah over the course of the, if you don't have capital at risk,
00:44:45
Speaker
then the IRS deems that hey you should you need to pay income tax every year on the incremental gains of that zero coupon bond, which is essentially what you're getting.
00:44:56
Speaker
So again, ah not to get too in the weeds here, but that's just that's another fun, complicated topic that that that these things can bring in. So as we kind of come to the end of our time together, I would like for you to tell our audience, if you are considering these types of products, whether it be a structured note through the calendar offerings or a custom offering or a buffer ETF or anything in in the the flavor of this, you know, what are the like five questions that they absolutely must ask when they're considering these products?
00:45:33
Speaker
So the main the you know the the the main question is the same question that advisors always have to ask with anything, was just suitability. ah you These things are not for everyone.
00:45:45
Speaker
um But specifically when it comes to these these products, you should you know take take a step back and think about you know what, if it is something more, if it if it is a vanilla thing, like just a ah something on the S&P, betting on the upside of the S&P, those are pretty competitive and those are pretty those are pretty clear.
00:46:10
Speaker
You should definitely, to your point, make sure you understand the downsides because the the upside there are are are pretty simple, but sometimes people get confused with what the difference between a buffer and a barrier and like you said, we were saying American and European.
00:46:25
Speaker
um So definitely make sure you look at that. um v When these things start getting more complicated, when you start adding other indices, when you start putting in different calls,
00:46:43
Speaker
honestly, like you, you, you should talk to, um or ask the salesperson, whoever is, whoever is talking this, uh, whoever's, you know, mentioning this to you, ask them how they're analyzing the underlying makeup of the options, because these things are all, they're all just, you know,
00:47:01
Speaker
It's just a combination of options packaged together. And so they should know what are all the ah the options that that consist you know that that make up this particular note that they're pushing and you know how those plate how those how those interact with each other.
00:47:19
Speaker
um And that's really, that's the that's the big question. And you know why so ask how they interact with each other and then why this one makes sense over something more simple.
00:47:30
Speaker
Because what ah what often happens is people hide um you know adverse terms in complexity. So when you see things that are that are ah you know sound a little like you that when you when you have to start really thinking about like what are the payoff structures going to be, you should immediately look at one of these things and understand the payoff structure of of like you know the the payoff graph in your head.
00:47:57
Speaker
If you have to start thinking about it, You know, it's probably something there's something going on where there's some added complexity that potentially doesn't need to be there. And almost always the added complexity favors the issuer and not the advisor.
00:48:12
Speaker
So I would say it's like the casino. um I will add to that list of questions. I think a simple way to think about it is um we do not work in a business that is a charity. These things are being issued for a reason because they are profitable and there's a profit opportunity here. So you want to think about all the ways that the issuer is making money and all the ways that the structure could favor them over you and what ultimately is the potential things that could go wrong on your end and how that that would impact the client.
00:48:49
Speaker
I always like to say For better or worse, and a lot of people don't like to think this way, you should always walk into these opportunities thinking about everything that could possibly go wrong, not everything that could possibly go right.
00:49:03
Speaker
um Even if the probability of the thing going wrong is low and the thing going right is high, you still want to understand what that looks like so you know what the worst case scenario would be from from jump.
00:49:17
Speaker
And then decide if the best case scenario makes the worst case scenario worth the risk.
00:49:23
Speaker
Completely agree. I'll just add one thing though, it which is most of the time, um almost all the time, the banks are not betting against you people we get this question all the time they're like hey i you you know i have this s p note from with goldman sachs goldman sachs is really smart does that mean does this mean that they're that they think s and p is going down no the goldman sachs and all these banks they view structure notes obviously as a profit opportunity for sure uh there's margin in them for them but it's also
00:49:55
Speaker
it's the reason they love these things is it's a cheaper funding mechanism for them because they they have all this risk on in their in their trading books anyway so what they're trying to do is they're trying to off offset the risk they already have on and then so like if they if they sell you chain a a note um an s p note somewhere else in their book they're they're long s and p now they sell you a note where you're long s and p making making them short s So now they're flat S and P and now all they've done is they borrowed money from you.
00:50:28
Speaker
So it's a simple the calculation of, is this money cheaper than if we issued, went out and issued, you know, short-term debt. so like, so that is what's driving it. It's not necessarily that that they have the opposite view of you. It's like they're, they have this risk on somewhere else and they're just viewing this as a funding mechanism.
00:50:49
Speaker
Oh, I absolutely agree with you. I think a lot of people always are thinking like, oh, they're doing this to take advantage of me. No, not necessarily. um it's They definitely have a profit motive and they're definitely doing it for a reason. Just understand what that reason is so that you can understand the dynamic in the relationship. But it's never, oh we think the S&P is going down and so we want to bet against it and we think you're stupid.
00:51:17
Speaker
um More often than not, that's not the case, but there's definitely some sort of risk mitigation that's going on, some sort of trade-off that they're considering that this is better for them from a profit motive. and um you know Ultimately, it's all the same. right you know As an advisor, you're choosing and selecting opportunities based on a profit motive yourself. And so just everybody understanding and aligning you know what the incentives are, I think is important. It doesn't make those incentives bad.
00:51:48
Speaker
That's what makes capitalism work, right? Everybody has a profit incentive. But it's definitely not as seedy and ah and and undermining and evil as people sometimes like to make it think um you know the people creating these products are just like me and you they have families they go home and they're not looking to like hurt people but they are like they're not they're not in a lab somewhere yeah like yeah that like dr evil going on like how can we ruin the world and for maximum uh gain
00:52:23
Speaker
um Yeah, so, you know, sometimes we talk about these things and I think sometimes we we do a disservice because we make it sound that way. But ultimately, all of us are aligning our interests in some way, shape or form.
00:52:37
Speaker
And just understanding where the the those incentives stand is like half the battle um because everybody's doing it for a reason. um And so I think that that's just an important thing to always be thinking about. but Uh, why don't you tell our audience where they can find you?
00:52:54
Speaker
Um, and, um, and anything else that you think we missed. No, I would just say that, hey, we're we're here to educate folks on structured notes. So these things like like we keep saying have gotten a bad rap.
00:53:10
Speaker
um i was I was one of those people for a long time. and and i'm And I'm also not like a I'm not an evangelist. I'm not saying that these are for everyone and everyone should use it.
00:53:22
Speaker
But they are really powerful and they are really useful. um If anyone is interested in just learning more about them, you know shoot me an email, Vinay at MarineLayerAdvisors.com or visit our website, MarineLayerAdvisors.com and shoot us an email.
00:53:39
Speaker
um We're happy to educate anyone on you know, what these things are and how they could potentially be helpful. Even if you have no interest in the product, you just want to learn more about it.
00:53:51
Speaker
I just think it's a fascinating thing. And and more often than not, we do we find that the more people get comfortable with it, the more they realize, okay, this is not, this is not what I thought it was. And, you know, this might make sense.
00:54:04
Speaker
Oh, one thing ive I will, I'll add. that we didn't talk about and is, you know you you mentioned the the negative connotation towards these things and it's completely true. i mean, I can't tell you how many meetings I walk into and people are like, no way in hell I'm ever using these things. I've never, well, you know, these things are evil.
00:54:23
Speaker
And by the end of it, they're like, oh, okay, maybe, maybe there's use for it. theres there's there's ah there's a use for it there's aka There's a big kind of age gap between the people who, the folks who've been around longer typically have a more negative view of these things than the younger folks.
00:54:39
Speaker
The younger folks who've come up you know after the financial crisis and all that um have a much more positive view and like tend to use these a lot more than some of the older ones. So like it's an interesting thing where you have a lot of the younger, newer advisors using these and you have a lot of the older advisors, which also makes a lot of sense. right If you were an RIA, been around for 40 years, you never touched any of this stuff.
00:55:04
Speaker
Or you you yeah did. Or you did. More likely you did. um Because our industry is great at prepackaging the same thing that didn't work the first time in a different way for marketing purposes. And anybody I remember, I had a derivatives professor that presented at a ah CFA Society of Boston.
00:55:25
Speaker
ah for me, um Dr. Simon, um may he rest in peace. um And he talked a little bit about how structured notes and portfolio insurance of the 80s, they're just flavors of the same thing.
00:55:36
Speaker
um but it doesn' it But he was also a derivatives professor who, like you, understood the underlying trading and was a fair... and a believer in derivatives. So he wasn't saying that these were bad, but I think to your point, you know the older generation has seen the different iterations of these things and is just increasingly more skeptical, whereas the younger generation hasn't quite been burned yet, but To your point, working with firms like yours can help the younger generation never have the experience the older generation did um because they can go in eyes wide open. And I think the eagerness of that the younger generation to learn is is something um that you know is helpfully going to help them not repeat the same mistakes of the past.
00:56:23
Speaker
Just with one thing that i'll I'll also add is this reminds me of my career in the options trading market. Like I mentioned, my first job, i was on the floor. It sounds insane now where people, we were trading in fractions.
00:56:37
Speaker
Like one of the big things we had to do is like learn fractions math really fast. Like that was that was like a big part of our job, which sounds crazy. um And now everything's electronic. Now everything's super efficient.
00:56:49
Speaker
But structure notes are like options in the early 2000s. and there' is way And they're getting more efficient. They're getting more modernized. They're getting more more accessible. And I just think it's a trend that's going to continue over the next you know five to 10 years because I've seen this movie before. And i've like it reminds me so much of the proliferation of of listed options.
00:57:12
Speaker
Yeah, absolutely. Well, thank you so much for your time. And thank you everyone for listening in to this episode of What's the Alternative? I am Shana Orzyk-Sysel, founder and CEO of Bondurian Capital Management.
00:57:25
Speaker
As always, don't forget to like and subscribe to this video and this podcast. Leave a review. Let us know how we're doing. And if you have an idea or a subject that you want to hear more about, please leave a comment and let us know. we want to hear from you.
00:57:41
Speaker
We will see you on the next episode. and go
00:57:48
Speaker
The opinions expressed on the What's the Alternative podcast are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or in any specific security.
00:58:03
Speaker
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00:58:15
Speaker
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Speaker
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Speaker
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00:59:00
Speaker
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Speaker
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Speaker
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