Could Structured Products Become The New Exchange Traded Fund (ETF)?
Written by Chris Olson on May 18, 2021
David Wood is the Managing Director of Luma Financial Technologies International Business and was recently featured in Wealth Briefing. We’ve included parts of the article below, but for the full story, please click here.
What parallels are there between exchange traded funds (ETFs) – particularly those which adopt more specialist garbs – and structured products? This article looks at the overlaps and what may happen to structured products in future.
This article delves into the structural nitty-gritty of specific investment entities: exchange traded funds, and structured products. These offer various ways for investors to tap into the upside of a market, profit from its downside, or blend a variety of events to their advantage, and do so with a range of precision. Structured products were hammered in the 2008 financial crisis, and ETFs have, by contrast, boomed during the past 10 years as stock markets – with some interruptions – rose higher on a sea of cheap central bank money. But what is the position today, and how should investors view these entities?
Growth in the ETF market in Europe in recent years has been remarkable. The region now accounts for $1.4 trillion of global ETF assets, second only to the US market in terms of size, with annual growth of 20 per cent over the last five years (1).
The success of the structure is hardly surprising. Transparent and accessible, ETFs offer simple exposure to a wide range of assets, such as commodities and corporate bonds, and hard-to-trade indices and themes.
As a structure, ETFs have long been compared with mutual funds which – while largely activity managed– broadly perform the same function. Less often, however, parallels are drawn between ETFs and modern-day structured products. Although there remain clear differences (as there are between mutual funds and ETFs), technological advances have meant that, in many ways, the broader comparison for wealth managers is becoming increasingly valid.
At the simplest level, both structures offer (largely) passive exposure to underlying assets, meaning that investors do not need to see a multi-year track record before investing. The exposures they offer have, over time, also loosely mirrored one other. Once, ETFs tracked the major market indices and little else. Now investors can trade different baskets and indices linked to a huge range of assets, with numerous weightings and balances. Structured products, with an added element of control, essentially offer access to the same types of exposures and underlyings, with similar tilts. In this way, the overarching journey of both types of structure has been broadly analogous.
What has changed in the last couple of years is that the wider ecosystem surrounding structured products has substantially narrowed the gap with ETFs in terms of accessibility and usability. Part of the reason why ETFs have been so successful is that they are straightforward to manage after purchase as well as easy to access. Historically, this has not been the case for structured products, which have more moving parts to manage and monitor. For a long time that process could be challenging for wealth managers, because it all had to be done manually, but technology has made it far easier and more efficient.
Today, where advisors will typically monitor client ETF performance through daily price feeds from stock exchanges or market data providers, they can do likewise for structured products through a platform, which will also offer them the tools to, say, directly match payoffs with the overarching objective of portfolios or see where correlations lie. Where reporting was once burdensome, now it has been industrialised in the same way that it has been in the ETF industry, making it far easier for wealth managers to provide key information to clients on a daily basis.
At the same time, another major barrier to usage – the difficulties in managing dozens of different products in client portfolios – has also been largely removed, with advisors now able to access tools that allow them to easily manage products and keep track of upcoming product events and maturities. That has been a big step forward in terms of efficiency and therefore cost.
Clearly, there remain major differences between the two structures. Structured products are not, like ETFs, listed on stock exchanges and traded like shares. Their cost structures differ (although they are equally transparent). Given the protection and different forms of payouts they offer, structured products are not seeking to compete with ETFs providing simple exposure to mainstream indices.
These additional complexities have typically meant that wealth managers face greater challenges in terms of control, suitability and education. However, education is now significantly better and more accessible across the industry (again often delivered via platforms), and that has given advisors more confidence and ability to use the structure. Also, now that banks have robust suitability models and checks when pricing products, facilitated by platforms, advisors can have a much more controlled, richer process when offering investment advice to their clients.
All this is welcome, but technology has really changed the playing field in terms of customisation. Once the exclusive preserve of the largest firms, wealth managers now have far more scope to create their own bespoke structured products for individual clients.
Here technology has upended the traditional approach to creating investments by automating processes once performed manually – often laboriously – at greater expense. With more automation and thus standardisation, the cost of creating products has come right down, making it viable for wealth managers to build fully-customised products for a much wider range of clients. That allows for an even more holistic approach to building investment portfolios.
Do these advances mean that we are going to see the same level of exponential growth in the structured product market as in the ETF market?
1, Source: CFRA, April 2021