Luma Insights:

Downside Protection in a Bear Market

As 2022 has shown, if there’s one thing we can be certain of, it’s uncertainty. Unanimous among the international collective of economic strategists, finance professionals, and investment experts, the year has been characterized by the oft-tumultuous behavior of the global economic market. What’s been the cause of the stock price peaks and valleys that have kept industry pundits with plenty of fodder for speculation? Take your pick. There’s been no shortage of variables colliding to create discord and confusion in the market. Persistent volatility, an unprecedented succession of interest rate hikes, monumental inflation on consumer goods…these actors have all played impactful roles in stoking fears of a looming recession. A bear market has been foretold and according to a growing consensus of economic prognosticators, it’s unavoidable. 

This begs the question: After a year of negative returns for many major asset classes, what can financial advisors turn to so that their clients’ portfolios are adequately protected regardless of market downturns? 

One answer that’s been gaining traction as a possible solution to impending economic turmoil has been found in alternative investments, such as structured products. According to a recent study by FT Adviser, one-third of investors in the United Kingdom said they’ve started considering ways they can integrate alternatives into their clients’ portfolio allocations. The key word being “considering.” The main reason they’re not taking action is because they simply don’t know enough about the opportunities that are outside of the traditional investment space. By honoring the trust they have built with their clients, they’re not comfortable taking chances on new investment vehicles without first feeling confident in their understanding of them. 

Before it’s possible to make any headway in withstanding the pressures of a bear market by using new tools, the knowledge gap that keeps advisors from picking up these tools needs to be addressed. Key factors that have created the rift between understanding and adoption are that many alternative investment vehicles lack transparency, have high purchasing costs, and are made up of complex parts. Even the alternatives that promise downside protection—i.e., equity long/short hedge funds—can’t be counted on as sure-fire bets for realizing consistent high net return rates.

These considerations beg the question: what is the best way advisors can diversify their client’s portfolio while simultaneously protecting them from the pitfalls of a bear market? Structured products can be the solution. For starters, because structured products are rooted in stocks with household recognition, they’re easier to understand than ‘traditional’ alternatives. Additionally, they provide well-defined parameters to their downside protection. That means that investors know exactly how much an underlier can fall before their capital is at risk. Third, structured products are customizable in a way that few other investments are, giving advisors the latitude to tailor products to the unique needs of each client (whether that is enhanced yield or high levels of principal protection). This level of risk mitigation as well as boundary setting create safeguards that are triggered when the market reaches specified levels. The result is stronger trust, better stability, and (hopefully) decreased panic which are all especially important when the market is erratic.

Adding to the security that structured products offer is the innovative technology that empowers advisors to reach the best results. Cutting-edge fintech platforms, such as the one provided by Luma Financial Technologies, allow for far greater transparency in the alternative investment market than ever before. 

No matter which way you look at it, bear markets are difficult to navigate. The good news is that, going into 2023, it’s possible for advisors to provide more comfort to their clients than ever before, not just by understanding the efficacy of alternative vehicles, but also by being able to wield them in a way that maximizes portfolio growth. With continued volatility on the horizon, it has never made more sense to diversify effectively by leveraging the no longer hidden benefits of structured products.