Animal Spirits Podcast - Talk Your Book: The Alternative to Alternatives

Starting point is 00:00:00 Today's Animal Spirits Talk Your Book is brought to you by Halo. Go to Haloinvesting.com. Some more about all the structured note products they have there as long as their brand new portfolio analysis tool called ORA. That's haloinvesting.com to learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ridholt's wealth. management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ridholt's wealth management may maintain positions in the

Starting point is 00:00:39 securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. Michael, can we call it Jebben's paradox for structured notes because all of the, is that, is that work or not? All of these new ETFs and buffers and defined outcomes and such, you'd think it would constrain the actual structured note space, but for a place like Halo, it's actually, it's grown still. You just went full-on AI brain. I love it. Right? Yeah. Does that work? I love it. It's great.

Starting point is 00:01:14 We've talked to Halo for a number of years now, and they've tried to make this structured note product space easier to digest for advisors, for investors, because it can be a complicated place. When you get into the derivatives that underlie, these things, right? I think people understand what the strategies are trying to accomplish. That's easier to explain than what underlies them. And as I mentioned on the show, that AI is perfect for this, for helping understand, wait, there's a lot of paperwork here. There's a lot to understand.

Starting point is 00:01:43 What is this doing for me? I think AI can help a lot here. It's kind of like coding for investing to keep the AI analogy going. It was one thing to use whatever software they built to understand the different potential outcomes, but to be able to wrap that, wrap your portfolio, around a couple of products and see how they integrate with the rest of the pie is very, very cool. Yeah. So they built a new tool that we talked about in the show. We talked to Matt Radgowski. He is the CEO at Halo, and we talked to him before. So we get it all, what's going on, how their advisors are using this, the portfolio analytics, which is a big thing, which I think AI is going to help just a lot of advisors and their clients just better

Starting point is 00:02:19 understand, like, what is going on here, what the attribution, how does this change things? They're obviously taking a big part in this too. So here is our talk with Matt from Halo. Matt, welcome back to the show. Thank you. I appreciate you having me again. Of course. All right. So you guys have been on the show a bunch.

Starting point is 00:02:36 I'll give you the opportunity to reintroduce yourself. But maybe I'll lead with this. The derivative income space has been a huge grower in the advisor marketplace. Buffers, overlays, a lot of the things that used to be exclusively home to the structured marketplace, which you guys play in. Now, one might think that there's some cannibalization. going on that you guys have struggled as this new liquid wrapper has brought these markets, these tools to the market, but we live in a post-cannibalization world.

Starting point is 00:03:14 The pie just keeps growing and everybody somehow, there's more money and everything is just growing. Do I have that right? You have it 100% correct. Yeah, no, absolutely. We love it. You know, the attention being drawn to the space, right? whether it's the auto call of ETFs, option overlay strategies, of course, structured notes,

Starting point is 00:03:35 really is bringing more advisors and the investors that they manage money for to the table, right? And so we love the attention, quite frankly. We think it's the right product set, and I'll use that generically, right? You know, the products that you mentioned there each have unique characteristics. They have unique places in the portfolio. But to your point, we've not seen the cannibalization. actually, we've seen the opposite. Our volumes continue to grow, wallet share continues to grow. So bring it on, right? I would have frankly thought the same thing because these products are getting a ton of

Starting point is 00:04:09 interest from people. Is it just, do you think a big part of it is just advisor use? Is it because we have these whatever 70 million plus baby boomers and they have a ton of wealth and they're looking for more products like this? What do you think is the reason for the resiliency of these structural products? Yeah, I'd say a combination. of secular trend in terms of investor behavior, looking for definition of outcome, security, right, as more money, right, is being put to use post-retirement. I think the need for security there grows. I think the newer investor, though, as well, the younger investor is seeing earlier on their interest in protection there as well. So you have just secular trends,

Starting point is 00:04:50 and then you have access to the product, right? So the ease of purchase and management, through platforms like Halo and others, I think is very important, right? So it's a combination of technology and access, investor demand, all coming together. And when you can buy, you evaluate, buy, and manage the products easier as an advisor, it's something unique, right, from a story perspective to bring back to your client. I think all those market forces have really created that resiliency that we're seeing there. All right, I'd love to know what is new in the world of Halo these days. What are you guys? What's keeping you busy? Yeah, so we are, you know, I mentioned technology, and I think technology and analysis, I'll say decision support for the advisor, we think is absolutely critical.

Starting point is 00:05:37 We are super excited. We've launched a tool called ORA, so Halo, aura, right? You know, our marketing genius is there. But really, the idea of ORA is to illustrate the impact of structured notes on a client's portfolio. So instead of kind of trying to decide in the abstract, right, what impact is this growth, note, this income note, level of protection, what impact is it having on the portfolio, we can now show empirically, right? Here is the impact improvement, or quite frankly, you know, if it doesn't show its value, we'll illustrate that to the client. But things like impact on expected return, negative return frequency, income that can be generated, you give or your current portfolio, you add notes to that portfolio, and we will actually

Starting point is 00:06:26 show you through a FINRA reviewed output, here is the impact for you as an investor based on that note allocation. And so you think about it in that kind of, you know, TAMP investment proposal context, right? So you can actually show the client why you're buying what you're buying. You can go into the lab and figure out what structure types are best for your client, given their objectives. And so we're super excited to get it into market. We've actually just launched already, and this is, you know, I don't want to stray into the power of AI from a development perspective, but, you know, we've been able to really iterate quickly. We actually just launched the version two of the tool, which moves from input and analysis to actual

Starting point is 00:07:08 allowing the advisor to share, what is my objective, what is my horizon, what is my outlook on the market, and we'll actually begin to curate notes for them in a more automated way. So, super excited about it. You kind of got that before I did. I was going to ask, these products because they have rules, there's a lot of stuff to read, there's a lot, right? There's a lot of fine print that's perfect for AI, right, to sort through, put them together. And I guess the thing is, if someone comes to the portfolio of these, you can, you can analyze them, but also if you say, hey, we're putting these three or four different products together, here's what the output is.

Starting point is 00:07:41 Is that the idea that it does seem like a perfect marriage for AI to use this stuff? Absolutely. Right. And you think about the number of, you know, combinations, right? whether it's underlier, protection level, duration, all these things. You used to have to kind of feel your way or guess your way or use shortcuts to get to product design. Power AI, right? You can actually calculate again the combinations of those things and really, again, analytically decide, is it the right?

Starting point is 00:08:11 We don't want the answer to always be, you know, allocate to this note, right? We want to make sure it's objective, but it does, you know, to your point, then really a allow us to analyze massive amounts of data and information, sum that up for the advisor, and then presented in a packaged form that we think, again, will really change the way these notes are allocated to within client portfolios. One of the things that I think is really interesting about what you guys have done in the structure marketplace is the technological aspect of it, making it really easy to, with the clicks, with the few clicks of a mouse, see all sorts of different.

Starting point is 00:08:49 strategies, you can do downside protection, which is obviously a conservative approach. You can do, you could like, there are aggressive strategies that you can use, right? So talk about all the sorts of different things that you can do with the platform. Yeah. So, you know, participation, right? You talked about if your focus is on growth and upside. And so, you know, we often talk about, you know, equity repair strategies with structure notes. And so when there's been some dislocation in the market and you're looking to repair, right, that equity side of your portfolio, you can seek out higher participation. So you pick your broad-based underlier, whether it's an index, ETF, individual security if you'd like, and you can actually have participation rates that go above

Starting point is 00:09:36 that 100% level. And so if you are again trying to generate growth in your portfolio, if, for instance, you know, back to the tool we were talking about in aura, if you have a bullish outlook on the market, You can, and in fact capitalize on that bullish outlook by taking upside participation through the structure notes. So it's it truly is a very, you know, it's that Swiss Army knife of investment products, right? In that you can meet, right, the investment objective that you have in that moment, given your view of markets and tailor that solution pretty nicely. And so it's really, you know, from a mindset perspective, trying to get the advisor to see, you know, there is always room for the note. inside the portfolio, the type of note you use, and to your point, Michael, the characteristics of it should in fact change over time given objective performance outlook, all those things.

Starting point is 00:10:31 So you said equity repair strategy. Tell me a little bit more about that. That's a new one to me. Say you have a certain asset class or sector exposure where you either have an extremely bullish outlook or you've had sudden negative return impact, right? So mean reversion would say, if it's going to go back to its longer term historical performance, there's a possibility to repair, right, that equity down, you know, that down draw you've had by allocating to a note that has some level of downside risk management, but also has a higher upside participation. So you're repairing that equity down, you know, that equity downturn through the use of the note, hence the repair. I'm curious about some of the other strategies that advisors are using too. One of the ones that we've had a ton of people

Starting point is 00:11:15 come to us with is just, hey, I have this concentrated position. I want to stay in it. I'm a little nervous about it. How do you have structured products and options that can help someone with that type of situation? Because that's something that we're seeing all the time now where people know, listen, I know that it's risky to have so much of my wealth in this one position. But I want to be intelligent about how I manage the risk around it or how I sell it or how, you know, I don't want to get out too soon. It's a huge worry for people. They don't want to make the wrong choice. Right. So how do you guys help someone in that type of situation? Yeah, you know, it's funny.

Starting point is 00:11:46 We had for a period of time, advisors came to us with that very challenge, that very problem. Well, we'll call it an opportunity, right? If you have concentrated wealth at a position, you're probably in a decent spot. And the question we got time and time again was, hey, can I use the structured note to manage that concentration risk? And the short answer, quite frankly, with the note is no, right? in that if you're buying the underlier, you're compounding it, right? But what we can do is using notes and accommodation of other tools get you to a good spot. And so we went out there into the market and looked for partners to help us manage those types of issues. And we came up with two

Starting point is 00:12:28 strategies that we can use to help. So there's the variable prepaid forward. And so where you can use derivative-based strategies to effectively collar that position. We have a part partnership with Morgan Stanley that's been extremely impactful on that very issue. And so identify the stock, right? You can put your protection level in, cap your upside, of course. But what comes along with that is the ability to borrow against that position. So you can actually free up capital. And then what we tend to do is with that free up, we can you purchase a more diversified investment strategy using structured notes, right? So you have that downside protection, but you're now in a broad-based index instead of a single concentrated position.

Starting point is 00:13:11 And so the variable prepaid forward has been a great add to our suite. We call this our advanced wealth solutions. And so beyond the structured notes and through partnership with Morgan Stanley, you can provide variable by variable prepaid forwards. And then we have a partnership with a firm called Derivity, which would be, I'll say for smaller balance clients that have concentrated stock, but still have that same issue that want to use an options-based, overlay within an advisory account. And so we've two companion tools to the structured note

Starting point is 00:13:43 to manage that concentrated wealth. And then again, we look to the structured note to provide that diversification with downside risk once you've addressed that concentration issue there. Matt, I have a few questions on the variable prepaid forward. Ben mentioned that's been a very hot topic for advisors as people's wealth has ballooned in Google and Apple and the rest of these these giant names. So, all right, a client has $10 million in Apple. They have a $13 million portfolio. So obviously, they are heavily, heavily overexposed to a single name. And they want to diversify. Can you walk us through how this works? So they borrow, they get $7 million in cash freed up. Their upside is capped. Their downside is protected. And what? Then they start to pay down.

Starting point is 00:14:35 they start to like sell down the individual holding Apple in this example or whatever the case may be. Like how does it work on a go forward basis? Yeah. So really on a go forward basis, it is, you know, quite frankly, it's a risk mitigation strategy, right? Because you are in fact, you know, like you mentioned, you're creating a floor and you're creating a cap, right? You know, in terms of the shares you deliver there. And you set those two parameters. And you really what it does is, you know, it allows you to. There's a tax play there, of course, right? You defer the taxes on that because you're not selling that security

Starting point is 00:15:14 until that final future date when you allow for that VPF to expire, and you get the cash, right? So you can borrow at Sofer. In some cases, the rates at which you can borrow against are pretty attractive, you know, currently through Morgan Stanley or there's others that provide them. That's just our partner there. But basically what it allows you to do is, again, lock in that upside and downside for a stated period of time.

Starting point is 00:15:39 Your typical duration of the VPF is 13 to 18 months, and then you can roll it forward if you so choose. You don't have to pay the entire balance back. You could take out another, you can roll the contract. That's exactly correct. Yep. You can roll that contract forward. Is that what advisors are typically doing,

Starting point is 00:15:57 or I'm sure there's a million different uses? That is exactly what they're doing. Normally they're rolling that, you know, they're rolling that contract forward. What's the cost of this? Because there's no free lunch. You mentioned like this that you have to literally pay for this. So it's a great tool.

Starting point is 00:16:14 You have to unlock liquidity from your existing shares. You're not all the way in on a stock that has treated you very well. And who knows what the future holds. But there's there's a price. What is it? You said SOFA plus? Usually, yeah, in terms of the borrowing rate. Yep, on the security itself.

Starting point is 00:16:29 I'm curious what other strategies people are administering these days because I Obviously, we're in a bull market, right? I think it's going well. Yields are a little higher now? Is it, are people trying to put their foot on the gas pedal more? Because, hey, things are going great. I'm willing to take risk. Or is it people who are nervous, a little all of the above?

Starting point is 00:16:47 Like, where is like the sentiment check in terms of your halo clients and what they're trying to do these days? Yeah, it's so funny. And I'm smiling because it literally is the gamut. It's, I've never seen, well, I shouldn't say never. Rarely do have we seen or have I seen a situation of where the advice base is so disparate in terms of their points of view. I mean, we have advisors that are all-end, right, the promise of, you know, technology advancement, AI, other things that are going to fuel

Starting point is 00:17:16 this growth into the distant future, right? So they are peddled to the floor. We mentioned some of those growth strategies. And then you do have the other side, though, where you have a constituency that is super nervous about valuations and where we are today. From my perspective, one of the biggest advancements that I'm excited about as far as you, product is, you know, we used to have, right, like in terms of predominance of strategy was in the structure notes side was on the income side. So really, right, you know, worst a basket, income notes to generate yield. We've really seen diversification of the product set, right, into the absolute return notes, into the growth, you know, pure growth notes. So you're seeing

Starting point is 00:17:57 now the ability for an advisor, whether it's their own view of the market or their clients view of the market. Some of them would have situations in which same advisor, two different clients, some buying highly protected income strategies, others buying pretty aggressive growth. And so not to bring it back to aura, but for us, right, like giving the advisor the ability to say, hey, look, express your view, right, in the form of market outlook, concern, et cetera, opportunity, we'll come back to you with notes, you know, that might be of fit. And so we're really seeing a shift in the advisor behavior in product utilization, which is really encouraging to us, but just more broadly from a market perspective, we have probably as many opinions as we have, number of advisor clients in that,

Starting point is 00:18:48 you know, some are super excited and think, you know, again, AI is going to fuel the next 10 years of growth. Others are, you know, just, you know, skeptical from evaluation perspective. the good news is we can help them both out in a way that allows them to continue to participate, but manage that risk. Obviously, it depends. I'm sure there's no data on this. I do wonder, the investor that has spent the last five years buying downside protection and capping their upside, I wonder if that person at this point is just pot committed.

Starting point is 00:19:22 And listen, if you've, let's say that you cap your downside at 15%, you cap your upside at 7%, I'm sure you're fine, right? That type of person that's nervous is probably very happy getting that 7% whatever it is. But I do wonder at some point, and this is obviously late cycle, Michael, who that rhymes, talking here? If at some point they're like, all right, I don't need this anymore. No more downside protection. I'm sick of cap on my upside. That's probably the very moment at which they need it most and it turns against that, right?

Starting point is 00:19:51 I mean, not to be tongue in cheek about it. But the other thing, too, though, I think that's really important. And again, why we are investing so much in the education and the tools and the, you know, that surround the product is making as, you know, making as, as sure as we can be that that advisor is communicating to the client exactly what is happening and that there's an expectation alignment. And therefore, when those results are seen, they can confidently juxtapose, which with the unprotected version of that product and allow for the client to decide. But I think as long as you, again, are, you can be overly conservative, for sure. But I do think that with the client

Starting point is 00:20:32 brought on that journey the right way, understanding what they're giving up, giving up, before that comfort and security, again, I think just investor behavior in general is moving towards that. I'm willing to give up. And, and, yeah, there are studies out there and we can, you know, I don't have them at my fingertips, but that have talked about that, that sentiment shift around I'm willing to, you know, investor base willing to give up upside for that downside protection. I think it's something that the advisor absolutely has to be ready to address. And it's the job of our team and our tools to say, look, we, you know, we are comfortable showing what you're giving up. There's no free launch, comfortable showing what you're giving up. But again, for that comfort of

Starting point is 00:21:15 knowing, look, if something catastrophic was to happen, you still have that protection in your pocket. One thing that's cool about these products that I spoke about earlier was how you're able to customize them to each different client's personality. That being said, there is something to be said about scale, leveraging your time. And if something is good for one client, it's probably good for at least a few more. Talk about the operational aspect of this, how it connects with our systems of record, whether it's, I guess let's start with the custodians as an example. Yeah. And so we have direct connectivity to the custodians. We also have access through aggregation tools that are out there in the market so we can bring those account details into Halo.

Starting point is 00:22:00 So you have that centralized control center. So the basic information around life cycle, cash flows, maturity dates, call observations, likelihood of call, likelihood of breach, right, approaching cap. Our control center, our life cycle brings that all to the finger. of the advisor. And so they can see it all there. Now, where have we invested in to make it even easier? There's a couple things technologically, right? So that aggregation service, so you can start to see all those details in an easy way across your accounts is great. We've launched a lot of management tools so you can start to see cash balances that need to be put to work within your client portfolios. You can set rules around product type concentration,

Starting point is 00:22:46 issuer concentration. So making that cash flow management easier is something that we've invested heavily with on the platform itself. And so going back to the Tamp analogy, right, rebalancing and reallocation tools, we've invested in the platform such that we're making that process a heck of a lot easier. And then from there, you do have as well. We've talked, I think, in the last time I was on, we talked a bit about the separately managed accounts. So we do have access. If you love the product and just don't want to deal with it anymore, you know,

Starting point is 00:23:16 We do have professional money managers you can hire to do that for you. Or what's happening in our large RIA clients today is their CIO is effectively building S&As that can be used across their client base. So kind of centralization of note decision making. So you guys obviously have people come to you with more traditional portfolios and, hey, structured notes make up 5%, 10%, 20%, whatever it is. How does that integrate with your aura system in terms of showing people what they're getting out of how it interacts with this other part of the portfolio.

Starting point is 00:23:49 Yeah, so it's great. I mean, we quantify for them, okay, you know, here's your standalone portfolio now, and here's its characteristics from a modern portfolio theory perspective. And then here is the change, right, in expected return, median return, standard deviation, downside return frequency, sharp ratio, all those things are quantified within aura and then displayed to that advisor. So they can literally see, okay, I've added this note. Is it doing what it's supposed to be doing, right?

Starting point is 00:24:20 Just given the, you know, given simulation-based outputs, right? But it actually quantifies, again, for that advisor that is that note an appropriate fit for that client. So I think best interest, fiduciary, right? Like, we want to make sure that from a compliance perspective, any product right in the wrong hands, you know, design with flaws can lead to bad outcomes. We want to, again, minimize the likelihood of that with the advisor base that we're, that we're working with. today. All right. So there's a lot of moving parts here. Even though it's not the most complicated thing, there are definitely things. It's a learning experience. So what would you say are the most common?

Starting point is 00:25:01 I didn't realize that thing that you hear from advisors. Oh, gosh. You know, what is the most common? That's a great question. I think, you know, I think a couple things. One is your understanding on the callability side, right? I think, you know, like the likelihood of notes being called, I think is something that, you know, they need to definitely learn about. The timing, right? So there is, you know, to me, right, there's a benefit to the product always. If you are opportunistic and you have your cash, you know, cash available to you, your dry powder, so to speak, the impact volatility, and spikes in volatility can have on the pricing, I think is something that is, you know, as much as we educate and tell the advisor, if they have the ability to be opportunistic and can, you know, I'll say kind of dollar cost average in, their understanding of that impact of shorter term volatility, I think is something that grows on them as they use the product more. As much again as we talk about it, right, the, you know, you're articulating those couple things I think are, you know, important to that an investor. I think those would be probably the biggest.

Starting point is 00:26:16 It is work, right? It is work. It is a zero coupon bond. I would say the other thing, too, is orienting them around the fact that today, at least, and we're trying and working with the custodians, the visibility, the way these products show up inside a custodial statement is not where the industry needs to be, and we're working on it, and we generate reports within the platform. But there are questions they get from their clients, right?

Starting point is 00:26:39 When they look and see, okay, why do I own? Why is, you know, 5% of my portfolio? in a, you know, Morgan Stanley or J.P. Morgan or Bammell Bond, right, not realizing there's an equity underlier to that. I would say that's another big, you know, another big aspect of education. You know, it's funny you mentioned that because I was just about to ask, earlier on during our discussions, and certainly a decade ago, this is probably like the number one asked question was about counterparty risk. People seem to be much less concerned with who was on the other side of this these days. And thank you.

Starting point is 00:27:14 God. Yeah, you know, and I do do not mean to discount counterparty risk at all. It is something there. And I think if you're diligently using the products, you want to make sure you utilize multiple issuers, not meant to discount the risk, but quite frankly, I mean, if you have, you know, if you have a situation in which an issuing bank is defaulting on their structured note, I can assure you there's something that in the capital markets that has gone wildly wrong. And we're probably, you know, fighting that that, that, that, that, issue on multiple fronts. We still, though, and we've talked about this in the past, we are still very much interested in supporting more issuers entering into the market. So leveraging the hedging capability, separating the note from the hedge, right? You've heard our co-founder Jason Barcema

Starting point is 00:28:03 talk about non-bank issuers. I think you're going to have more banks that come into issue. I do think you're going to have non-bank issuers. And we are at the ready there with the technology infrastructure to support those programs. And I do think as demand grows, I think what will happen first is supply will become constrained before counterparty risk becomes a, you know, I'll say a marketability issue. And we're at the ready to help on that front for sure. That was another bull market Michael one, right? Well, is that fair? Anything else you guys are working on these days in terms of helping financial advisors? You mentioned some of the defined outcome ETF strategies out there. We've observed right? We've not jumped in. That is something I will tell you. We've gotten a massive amount of

Starting point is 00:28:48 interest in engagement from other asset managers, the issuers themselves, and our advisor clients. I would expect that you'll see, quite frankly, you'll see Halo product in market here at some point in the future. We definitely feel there is improvement that can be made in terms of the buffered ETFs, the auto-callable ETFs that are out there. And so we're being very, quite frankly, diligent and cautious about how we would enter. But that is something that we're working on as we speak. And then the other thing, you know, going back to ORA, you were building on that AI infrastructure, you'll see more generative output that can help guide that conversation with the client.

Starting point is 00:29:30 You know, we're excited about that. That should be, you know, later on in this year early into next. And then, you know, we talked about the supply side. So tokenization of structure notes. You know, we've done some work there. We have a partner in a group called Ironlight. We've built out a proof of concept. And, you know, in the lab, we've tokenized structured notes. We do think that's something that longer term will create, you know, just as it is with other asset classes, quite frankly, there's, I think there is a benefit in that in that structured note world for tokenization. But again, it's, you know, the more broad trend around, you know, tokenization of assets. We do feel it will come to the structured note space. we're ready there with infrastructure to help support it. I know you asked for one, and I threw three at, Jeff. Sorry about that, but yeah, we got some deep things going on here right now.

Starting point is 00:30:20 We're super excited. All right, if we want to have advisors, learn more where we send them. So haloinvesting.com. Perfect. All right. Thanks very much, Matt. Thank you. Appreciate it.

Starting point is 00:30:31 Okay, thanks to Matt. Remember, check out haloinvesting.com. To learn more if you're an advisor, and then email us Animal Spirits at the compound news.com.

Animal Spirits Podcast - Talk Your Book: The Alternative to Alternatives

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