All you need to know

A spokesperson for one of the global investment banks selling structured products to the retail market accidentally tipped the firm’s hand to readers of the Wall Street Journal. Amidst an investigative article about $22 billion in “structured CDs” now being held by mostly unsophisticated households, comes this explanation:

A Barclays spokesman said in a written statement the structured CDs market has “seen significant evolution over the last few years to meet the needs of clients, investors and distributors seeking to navigate the continued challenges of a low interest rate environment.”

Let me rewind that with a bit of emphasis:

A Barclays spokesman said in a written statement the structured CDs market has “seen significant evolution over the last few years to meet the needs of clients, investors and distributors seeking to navigate the continued challenges of a low interest rate environment.”

Hang on…why do the needs of “distributors” matter to this equation?

This is the difference between banking / brokerage vs fiduciary investment management in a nutshell. Bank salespeople and brokers can make as much as 3% by selling a client structured CDs versus the traditional CD that fetches much less. The yield-starved environment is driving the demand for these products, and the results for those who are sold them are not so great according to the story (and according to common sense).

If you don’t have a financial plan in place, then this sort of stuff can sneak past the goalie. If you do have a plan, then it’s hard to justify including these – they don’t match the needs of any real-world objectives you’ve laid out versus more conventional alternatives.

In late 2002, a UBS salesman came into my broker-dealer and pitched us on a “Tech Leaders” structured product, where clients agreed to lock up capital for five years that would be ostensibly linked to the performance of Cisco, Lucent, Microsoft, Intel and other fallen giants amid the rubble of the dot com blowup. They were guaranteed interest semi-annually and their principal back at the end of five years, so it sounded like a no-brainer.

Until you read the fine print.

Your downside was protected, sure, but you were about as linked to the stocks in the prospectus as I’m linked to Charlotte McKinney. Which is to say, not at all 🙁

Because the upside that any client could receive from these notes was capped at 1% per month. Which meant that as these stocks staged their massive recoveries in fits and starts, our clients weren’t getting any of the benefit. Cisco up 9% after beating earnings, Dell ripping 11% as the company gets into storage devices, etc – none of it mattered. Except to UBS, which had sold us a bottle of wine but kept everything save the cork. We didn’t fully realize the consequences of what we had bought until after the fact.

Structured products for the retail market are made by foxes, sold by wolves, bought by sheep.

You can call them “CDs” or “UITs” or “Reverse Convertibles” or whatever you’d like. At the end of the day, there are much fewer scenarios for which they’re actually needed than there are in which they’re marketed to the masses.


Wall Street Re-Engineers the CD—and Returns Suffer (Wall Street Journal)

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