By Jasen Dahm, CFA, CPA

Rising interest rates and volatile equity and fixed markets have financial advisors and investors looking for smart ways to balance risk and reward in their portfolios.

Maintaining or controlling that state of equilibrium often involves diversifying investments across multiple asset classes that perform differently in various market conditions, thereby hedging against portfolio downside deviation.

One such approach gaining popularity over the last year is the inclusion of structured products in investment models. These products are securities tied to an index or a basket of indices or individual stocks and designed to meet specific financial objectives with returns based on the performance of underlying assets. They can be used to improve Sortino ratio, a measure of return over downside capture.

Structured products offer opportunities for greater diversification and a degree of principal protection, but also come with their own unique set of risks.

Some of the primary concerns associated with structured products are:

  • Limited liquidity or complete illiquidity – typically unable to be sold before maturity which requires investors to buy and hold for the long term.
  • Financial strength of the institution you are partnering with known as counterparty risk – if an issuer becomes insolvent or files for bankruptcy it may default on contractual obligations and not pay out.
  • Terms and conditions – may be less familiar and more complex than some traditional investments.

However, with demand growing, Mark Kelly, CFA, Case Liaison here at TAG Invest is introducing a small number of structured product into an alternative core portfolio. Within these models, a portion of several asset classes will be represented by structured products using a single index that are easily tracked, tax-advantaged and have straightforward terms.

Our goal with these offerings is to maintain the upside to certain equity markets, while providing some level of downside protection, specifically a buffer.

With downside protection being buffered, rather than barrier protected, clients will miss the full downside of a market swing over the structured products’ target maturity range of two to three years and returns will be taxable as long-term capital gains.

TAG Invest has enough demand to achieve economies of scale with these structured product offerings to offer significant value by lowering the costs of entry into some equity markets, limit exposure to potential losses and customize the notes to align with specific investor goals.

In some cases, these offerings look more attractive than owning the underlying index fund, when looking at risk vs. reward parameters. The combined note positions will represent a maximum of 10-15% of equity exposure, so a 60/40 investor would expect a 6-9% allocation.

Jasen Dahm, CFA®, CPA, is Managing Director of TAG Invest, the investment program available to TAG Advisors. He consults financial advisors on asset management, tax planning, liquidity management, and advanced case design. His prior experience includes running an asset management program, accumulating and managing over $1.1 Billion. He is also author of the Amazon best selling book Nutshells: Planning Strategies for a Tax-Free, High-Income Retirement

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