While the vast majority of financial advisors have incorporated liquid alternative investments into their clients' portfolios, they may be ignoring one illiquid opportunity in the current environment.
Just 22% of advisors told research and consulting firm Cerulli Associates that they currently use some type of structured note investment in their clients' portfolios, but 8% plan to do so within the next year,
Structured notes are "poised for growth" amid
"The returns for these types of structured notes sit somewhere between traditional debt returns and equity returns," Nayef Perry, the
Borrower demand is adding to the availability of the products as
"It's a good way for them to take on incremental capital without consuming cash flow in the form of interest expense," Perry said. "It becomes a very cash-flow-friendly tool for borrowers."
The Financial Industry Regulatory Authority and the Securities and Exchange Commission
"Importantly, a structured note doesn't hold an actual underlying portfolio of investments like a mutual fund or ETF does," the regulator said. "Instead, the issuer of the note promises to pay a return based on a formula that incorporates the performance of one or more reference assets."
When asked by Cerulli and alternative investment research firm Blue Vault about the main challenges to investing outside the standard 60-40 portfolio, the most common response among 54% of advisors was that the products tend to have a lack of liquidity that makes them unsuitable, followed by the difficulty of due diligence for complex instruments (40%) and the cost of the vehicles (34%). At least 82% of advisors said they currently use liquid alternative ETFs, and 79% said they have liquid alternative mutual-fund holdings. Closed-end funds (30%), private equity (30%), non-traded real estate investment trusts (27%) and hedge funds (23%) came in closer to the share of advisors with current structured-note investments at 22%.
"Structured notes may face headwinds for an immediate uptick in use as less complex products such as [certificates of deposit] have been able to satisfy investors' need for income. Those seeking additional upside may be compelled to re-examine structured notes," according to Cerulli. "An average structured note user likely is seeking consistent income. For wealthier clients, advisors typically cite the downside protection of using conservative structured notes as a key reason they are implementing them. Early advisor use of structured notes is often something mundane, such as an S&P 500 linked note, before progressing to other, more complex indices. Clients seeking income can reach for higher upside than can be found in a CD while still limiting downside."
Advisors, their clients and other global investors poured at least $93.7 billion into structured notes in 2022, which was second behind a record level of sales north of $100 billion a year earlier, according to
Technology firms and issuers are collaborating to make investing in such complex products easier for more advisors and their clients, Cerulli noted, citing the rising number of platforms available to advisors through firms such as iCapital, CAIS, Halo Investing and NewEdge Wealth.
"A large portion of fee-based advisors struggle to implement structured notes as a core portfolio allocation because most products are designed with brokerage business and high net worth clients in mind," according to Cerulli. "However, new note issuances increasingly are able to be seamlessly slotted into fee-based accounts, removing a potential obstacle. With structured note use set for an uptick in the coming year, advisors would be wise to revisit the product as innovation has rejuvenated investor interest."
