Talk Your Book: Custom Portfolio Protection

0:00Today's Animal Spirits Talk Your Book is presented by Halo Investing. Go to Haloinvesting.com to learn more about their structured note platform and also their brand new SMA marketplace. If you're a financial advisor, go check out haloinvesting.com to learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick 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 Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:37Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:45Welcome to Animal Spirits with Michael and Ben. On today's show, we're joined by Matthew Radgowski. Matthew is the CEO of Halo. Ben, one of the things that's exploding in popularity or access, I should say, in the wealth management industry is customization at scale. And those things might sound like they're contradictory because how do you achieve such a feat? Well, luckily, there are now platforms like Halo that are as much technology platforms as there are financial platforms. Back in the day, creating a portfolio of structured notes would have been laborious as all get out. I like that phrase, all get out.

1:24Don't say that too often. You should see how big the private placement memorandums are for an individual structure note if you went straight to a bank. It's like 200 pages of legalese and it's a lot. Yeah, it's a lot. No, yeah, but I do think there was this shift for simplicity in financial advisor space going from active management to index funds that took place. Check the box, done. Yes. But then people realized we have to be more customized to the circumstances, needs, and desires of our clients. And that is where things are going. I think that's the 2020s decade to me is advisors learning how to customize for their clients, whether it's taxes, investments, income, downside protection, whatever it is, customization.

2:09So we've had Halo on a couple of times in the past to talk about how structured notes work, the downside, the upside, the soft protection, the hard protection. On today's episode, we expand a little bit more into some of the new things that they're getting into. So hope you enjoy this conversation with Matthew Adagowski.

2:27Matt, welcome back to the show. Thank you. Yeah, appreciate the chance to get back here. Hope all has been well. All has been well. Thank you for asking. So we've had your predecessor, Jason, on a few times. You've been on once before. But for people that might be new to your platform, remind the listener, who is Halo? What are you doing? Who do you serve? So Halo is an investment technology and marketplace for protective investments. So we offer the ability for financial advisors to find and buy structured notes, fee-based annuities, and other protective investment products. We'll talk about our SMAs today, but we connect the manufacturer of those products to the consumer, which is the advisor who uses them in their client portfolios, offering a wide range of access to investment banks on the structured note side, insurers on the annuity side.

3:15These types of products seem to be exploding in popularity, and not only from your side of things, but also on the ETF space. There's a lot of other option-type strategies. Michael and I have talked to a number of different managers that have these types of strategies, and we get questions all the time from our listeners asking, what do you think about them? Because I think people really like the sort of defined outcome nature of these things, right? They don't know exactly what their outcome is going to be, but they have a couple of different paths to go depending on what happens, right? And so it's a little easier to understand for people, I think especially for older investors who don't want as much risk and want to have things be a little more certain.

3:50So how do you all separate yourselves from the ETF space that's coming in and having these more options-based strategies? What would you say the biggest differences are? Yeah, so it really comes down to, you know, it's balancing out, I'll say, the ease of purchase versus the ability to tailor and customize. And so the buffereds that you're talking about, buffered ETFs, do offer the ability to provide protection to the investor through the purchase of that ETF. It's tickered, so it's easy. I would say the structured notes do offer the ability. We think about personalization as a key dynamic in the industry today.

4:28The structured note, given the individual nature of that note, the bond that it is, it does allow the ability to increase the personalization of that strategy. So you think the ETFs are complete garbage, hot garbage? No, not at all. I think about it in the spectrum of needs, right? So as far as ease of implementation and liquidity, right? So certainly the ETF has the highest level of ease of implementation and liquidity. Giving up some of that ease of implementation, you gain, right? And so it's all about trade-offs. I think I'm actually personally excited about the fact that more people are interested in defined outcome investments that offer the appreciation with the protection as well as income.

5:13And so I think for the industry, it's good that we're paying more attention to these products. We believe that the structured node is a great mousetrap, quite frankly. And we're trying to build better technology to make it easier to access and manage these types of strategies. The concept of protection in a portfolio, and Jason speaks about this. He said, you insure your house, why wouldn't you insure your portfolio? And I think the purist would say anything that's going to put a flaw in your downside is going to eliminate some of the upside, to which I would say, yeah, okay, fine. If you are a young person, not like Ben, but like myself, if you are a young, vibrant person and you've got a long time horizon and you've got the ability to stomach 50 % drawdowns, why would you cut off any of your upside?

5:59However, this is a behavioral science, a behavioral exercise, and not everybody can handle all the smoke. So what I find intriguing about these products that might sound antithetical to the buy and hold type of ethos that I have is that not everybody can handle all of the downside. And so what these give you is a way to define, Matt, you said personalize. So you can say, okay, this downside, that upside. Nah, I don't like that. This, that, no. Okay. Oh, that one I like. You could define your terms. Absolutely. I've spent a lot of time and career building glide paths. So if we kind of think about it into the future, we'll talk about some of the technology we're building later.

6:44But if you think about the traditional glide path, you mentioned earlier investors have more long-term horizons and they can afford some of that volatility. The way we're thinking about structured notes is along that protection path. So as you move through time, your ability to withstand those downside events grows less and less. And so traditionally, we've taken equity risk off the table, put it into fixed income. Now, that just creates a different risk, just in terms of shortfall into the future. There's inflation risk and things of that nature. So you're trading risks. And so for us, as you move through time, your ability to dial up the protection while maintaining that equity exposure is absolutely critical to success, right, in terms of building the wealth you need.

7:29And then quite frankly, you're making sure it can sustain your needs through retirement as well. One of the things that we've talked about over the years is just the fact that the pricing on these things can and will change depending on market dynamics, right? It's interest rates and volatility. And sometimes the timing on these things and the type of environment you're in can dictate the types of yields that you're able to earn on these structured notes. So maybe you could take us through where we are today with being in a bull market, but also having rates much higher than they were in the past, maybe than the first few times we talked to Jason when rates were much lower.

8:00Yeah. So I think what tends to happen is the use of the product, the type of the product tends to change given the rate environment as you think about use and implementation. I think volatility is obviously a key driver in the pricing of the notes as well. And so a couple of things I'd say there, obviously, well, maybe not obviously, but recent spikes in volatility, you'll see activity grow. We'll talk about why using a professional manager inside our structured SMAs can be helpful as far as some of that timing. But if we look at it on a year-over-year basis, as rates increased and maybe some of the income-oriented users of the product start to wane, growth notes, right, where you're participating in the market on the appreciation side with downside risk protection, those products certainly come into play.

8:49Yes, it impacts pricing, but overall, if you think about the impact in terms of maintained participation on the upside but downside protection, they're still a valuable tool, even in the interest rate market we have today. You'll also see from an income perspective, what tends to happen is more creativity in terms of the underliers. You'll see different indexes used, different underlying individual equities that try and, again, help maintain the income exposure that that client is seeking. So yes, there is dynamics around pricing, but all in, still feel there's valuable use regardless, quite frankly, of the current situation around volatility and interest rates.

9:36So Matt, you guys built the platform based around the idea of protection, structure notes, customization, technology, all that good stuff. What else have you been up to? What's new on the platform? Yeah, so the StructureNote SMAs, so Separately Managed Accounts, this is a program we're super excited about. It offers the ability for advisors to use StructureNotes in their practices and portfolios. But similar to models and other separate account strategies, it allows them to utilize as a professional money manager, to do so. And so excited about the launch of the program. We've had some recent news in terms of expansion of access through places like Invested and SmartX.

10:20But we're super excited about the program and what it offers. So what exactly does that mean? Is this like a best ideas collection? Like what does the SMA look like? Yes. And so the Halo platform, you think of the Halo platform as, quite frankly, think of Halo as a traditional separate account program sponsor. And so what does that mean? And we act a lot like a TAMP in terms of the implementation and ongoing management of the strategies. And so we provide all of the operational infrastructure for the investment manager, right? So they need to source, build, and manage their portfolios of structured notes.

10:56We offer them our platform to do that. We have investment expertise in-house to curate. So it's a curated list of managers today. We can talk about who they are and the strategy types, but it's not a full-blown marketplace, at least today. It is a curated list of managers. And then on the investor side, it's really all of the infrastructure that they need to evaluate, select, and then monitor those separately managed account allocations within their portfolios as well. So is this, I'm curious, did you build this because although some people really love the customization piece, other people would rather just have the sort of access or the exposure to structured notes and want to pick a certain style.

11:41Is it one style? Are there multiple? Is it a conservative, a moderate, and aggressive, whatever it is? Are there different styles that you can choose, or is it one whole strategy? Yeah, so let's jump in a little bit on the strategies, then we can talk about who's using them, why, and how. And so today, we actually we have five structured note strategies that are available from three different managers. So New Edge, Piton, and WisdomTree. In terms of the strategy types, they do differ. They really follow along, I'll say, two main lines, income. So those that are looking to utilize the structured note to generate periodic income within their portfolios.

12:18And they can do that to replace fixed income, or they can do that to basically try and drive equity-like returns, but using those those coupons. And then growth, growth-oriented investment strategies from both NewEdge and WisdomTree that are really focused on participating in a market upside, but also providing that downside risk mitigation. If we dig even a little further into that, you have WisdomTree, right? Unique investment strategy that really follows along their ETF models. So if you're a user of an ETF strategy, you can use this to replace your equity side, equity growth-oriented investments, but provide that downside protection.

13:01And so we also, it's interesting, as we traveled with our advisors, we received some asks around fixed income. So we have an intermediate fixed income strategy, as well as an ultra short. So when coupons are paid or when capital is ready to deploy, we talked a little bit about pricing and the movement of, we have an ultra short strategy it allows you to keep your cash while you're looking for those opportunities. And so, yeah, really trying to make sure the objective, right? So are you seeking appreciation, preservation, or consumption? And how are you thinking about balancing those things? And then the investment strategies align.

13:36We curate them to align with those objectives. And so, interestingly, from a user perspective, it's a combination of those that we go out that are new to notes and basically say, love the concept, just not ready to build and manage strategies on my own. And so they can use this to get themselves into the product using a professional manager. And then those, quite frankly, that are experts that say, you know, my practice, my structure, I want to build scale and efficiency. Again, love the product. I want to use that manager. I know how to integrate it into my portfolio and want to use that professional manager for scale and implementation.

14:13I'm trying to wrap my head around this. So walk me through this. So WisdomTree has a model portfolio. They and others have been in that business forever, working with advisors that are more planning-oriented and say, we'll get the investment side. So they're doing that, but they're using Halo to build a model portfolio based on structure notes? That's exactly correct. So if we think about the growth strategy offered by NewEdge and the growth strategy offered by WisdomTree, the whole idea there is to align with your equity allocation, right? So take a portion of that equity allocation, put it in that growth portfolio that has downside risk protections for the notes.

14:55Why would you do that, right? So - Yeah, like that's what I'm trying to figure out. Yeah, yeah. So it really, back to the core principles of the note, it is meant to maintain that equity exposure, but reduce that downside volatility. And so I'll say a super practical use case. There's two super practical use cases that effectively illustrate why you should have these in the portfolio all the time. But you have individuals that are looking to put money to work, are not sure if it's the right time to do so. So they have money to put to work. The advisor is trying to convince that investor to get into the market.

15:31The structured note allocation can really help get money off the sidelines. It's providing that - I buy that. I buy that. And so when it's there then, so it's getting that money to work, get it in the market, because obviously, as we know, you need equity investments to get to where you want to go, obviously, unless you're ultra, ultra high net worth. Once they're in that strategy, our feeling is that it also helps maintain consistency. So because you have that downside buffer in the portfolio itself, when things do get volatile and the investor begins to question the flight out of strategies when stuff hits the fan, it does offer the ability to keep them in that strategy.

16:13So the whole idea is to get them invested in the market and keep them in that model based on an allocation to the structured node SMA. So that part of it resonates with me. As I said earlier, if we're all cyborgs, nobody would need any insurance. We just ride all the downside, ride all the upside. But of course, that's not real life. So I've actually had a couple of conversations in the last weeks, even with like younger people that have way too much cash that are waiting for a pullback. Who knows when it's going to come? Who knows how it's going to, how they're going to behave when it actually does come right.

16:44Maybe like, ah, I can knock it by now. Wait for a deeper pullback. So for people that are like trying to dip a toe in the water, Matt, you look like you're salivating. I love that. So for people that need an entrance into the market but are uncomfortable just buying today, this is a potentially really good option. So talk about how this works. Is this, all right, we get into the portfolio and these are six-month maturities or two years? So how does this work? And then how do we get them – I know this is not to your benefit, but as an advisor, how would we get somebody out of this and into the – I'm looking at a better metaphor, but like a raw dog exposure where they're fully in, forgive me.

17:28I love it. So yes, you saw me salivating there. It really is, in terms of focusing on the investor, the outcome that they desire, that cash, right? There's a lot of it today, right? Sitting on the sideline, tons of it, right? And so you're exactly correct, right? So the structure note does offer the ability for them to say, OK, get into the market. We don't know when that next pullback is going to happen. You don't know if you're going to miss the run up. And so now is always the best time. But what we're also saying is we understand your concerns, whether they're behavioral or whether they're from a horizon perspective, if you don't have the luxury of losing money now or if you're just super concerned about it.

18:14the note definitely, again, allows you to invest in a broad-based index exposure. You can create notes that are, again, associated with individual activities. But again, it entices them to do what they need to do, which is get that money to work and do it now. And so you mentioned, right, when do you move from the structured note SMA to the individual? It really, quite frankly - Don't say never. Yeah, right. So, of course. But I look at them as valuable, again, back to the question first around using buffered ETFs versus using structured notes. I think there's the ability to use both of them effectively in practice, as well as individual notes, individual notes and the structured note SMA.

18:58And so I think of that structured note SMA as more of a core integrated allocation that should remain, right? So depending on the risk type of the investor, the size of that investment, right? And hence the protections that it offer, you want to allocate in size, but keep it in there, right? How about this, Matt? Sorry to cut you off, but how about somebody's like, all right, I've got whatever, this pile of cash and I'm nervous. So what if, okay, I understand, right? I get nervous too. What if we're going to take – I'm making this up. 40 % of the money, we're going to put it in this structure note model wrapper.

19:38We're going to take the remaining 60 % and put it on with note protection. And this way, if your worst fears come to fruition, at least we've got you some insurance. That's it. That's absolutely correct, right? And then I would say the pivot to when you start using the individual notes, right? So as your experience grows, well, taking a big step back, we are super focused on integration of these products into the portfolio allocation process. They can't hang off the side of the desk. They need to be part of that core allocation model. So now you've gained exposure to the structure node through our professional managers.

20:11Now you see in your own practice, whether it's from a valuations perspective, from a macroeconomic or geopolitical, you see some dislocation in a sector, in an asset class, in an exposure. You then, once you have that expertise, right? So for instance, if you want international exposure these days, right? Let's go China. Talk about China because China was probably blown out less. You probably had great opportunities there. For sure, right? And so those are situations where if you as an advisor either think there is, from a valuation perspective, dislocation to the low side, right? So undervalued, right?

20:51Or overvalued. If you still want to, again, express or maintain an exposure that you have in your model, but you want to do it in a highly, I'll say, tactical way, though aligned with your core allocation strategy, the node's perfect, right? So we have a ton of interest today. You mentioned China, but also like Eurostox, right? So international exposure, Europe in particular, the participation in some of those notes are absolutely phenomenal with decent downside protection as well, strong downside protection, I should say. So again, as you become that note expert, whether it's China, whether it's Tesla, whether it's Euro stocks, whether it's small caps, you can use that structured note in collaboration with your other allocations, whether the structured note SMA or your core portfolio.

21:41And that's the whole idea of Halo, though, is to teach advisors, right? Educate them not only on what they are, right? Education sometimes is around like deep, dark infrastructure around how the node is built. But it's as important to us to show how do you actually put this in a portfolio? What's its role? And then how do you, again, adjust it over time based on these market dynamics? For the SMAs, is there any difference between in the liquidity structure or the fees or anything? Tell us how that works compared to the other platform where you're creating them yourself. Yeah, so there is. So as with any externally managed strategy, so SMA, there are advisory fees associated with them.

22:21And so they vary by the strategy and strategy type. What you're looking for, anywhere from 40 to 80 basis points in terms of the advisory fee that's associated. So that's the fees you're paying for the professional management by those New Edge, PITON, or Wisdom Tree. And so you get very similar to using other SMAs across other asset classes, but that gives you some sense from an advisory fees perspective. So if you're managing them on your own, you come to our platform, you source a note, you're only paying, I'll say, a transaction fee on the note itself. We've talked about pricing structure for notes.

23:05Typically, these are sold in advisory accounts, right? So the advisor still charges what they charge from an advisory perspective. And then the cost of issuance and the cost of delivery of that note is embedded in the re-offer of the bond. What about implementation? Is this something where they click a button and all the notes are bought? Or is it like, I have to go, I have to do this part of it, and this part of it, and that part? Yeah, that's the beauty of the platform. And so you can go out to haloinvesting.com if you're onboarded with the platform. And similar as you would see in a typical SMA infrastructure, you have access to information about the strategy.

23:45What is its objective? Who is the manager? Historical information about the strategy itself. You then basically, yes, as you point out, you click to buy the note. Now, I will say it's just as simple or just as it's similar to buying a separate account strategy as a custodian, as you would at a custodian today. And so from an operational lift, you have to make sure, obviously, you have an account open at the custodian. And then there's the investment management agreement. And then with the advisor, we have our platform services agreement. So again, nothing out of line with what they would expect to see and engage on a traditional TAMP-like infrastructure and a separate account strategy.

24:30So the customization is fantastic. Advisors love that. Clients love that. But how does that contrast with scaling, right? Like the ability to do this at scale, does the customization make that tricky? Well, so customization at scale, right? This has been industry focus across all products for a long time. You've seen the advent of model portfolios to really try and help address that, right? So create models that have objectives such that they can be used in different sizes at different times to personalize and customize, right? And so the whole idea of the technology infrastructure is to basically make this easy for the advisor to do at scale.

25:16And so they have note types, right? So the platform itself allows them to curate notes, create watch lists for notes so that they can monitor pricing or pricing or terms. And so the whole idea of the platform is to easily buy them and deliver them back into the client portfolio. Now, when you talk about that integration at scale, we're launching a tool called Aura. And the whole idea of Aura is to demonstrate the impact of that structured note inside the client's portfolio. And in the case of an advisor that uses models, we demonstrate the impact of that model or that impact of the occlusion of the structured note SMA or individual note in that diversified asset allocation.

26:02And so back to scaling, right? So in order to drive the adoption of that across their investor base, or in the case where there's models used at the home office level, you can demonstrate to that investor what is the impact that the note is having? Why is it there, right? And so in terms of easing the adoption of the product, it becomes, for us, we're convinced it's much more seamless when you can show, right, here's the impact on risk. Here's the impact on negative returns. Here's the impact on income, if that's your focus, of the notes. Kind of think about it in a traditional TAMP investment proposal framework.