Structured Products Are Back. Why the Boom and What’s the Catch?

0:00The thing about AI for business, it may not automatically fit the way your business works. At IBM, we've seen this firsthand. But by embedding AI across HR, IT, and procurement processes, we've reduced costs by millions, slash repetitive tasks, and freed thousands of hours for strategic work. Now we're helping companies get smarter by putting AI where it actually pays off, deep in the work that moves the business. Let's create smarter business, IBM. Support for the show comes from public.com. If you're actively involved in your portfolio, you probably catch yourself repeating the same actions.

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2:34Learn more at the Hartford dot com slash risk mitigation. Bloomberg Audio Studios, podcasts, radio news. The Fed cut interest rates by 25 basis points Wednesday and signaled that two more cuts could be coming this year. Where we got pretty much exactly what the market had expected. In anticipation of the announcement, stocks had been climbing. But then the news dropped. But once people started parsing the dot plot and started parsing what Jay Powell had to say, stocks flipped back with the S &P, the Nasdaq ending in the red, and a 2 % rally in the Russell being almost entirely erased. Fed Chair Jerome Powell got to the heart of the market's concern in his press conference.

3:18There are no risk-free paths now. It's not incredibly obvious what to do. Inflation is still elevated, and the labor market is showing signs of weakness. It's all keeping investors on edge in what's already been a particularly tumultuous year. The stock market here in the U.S. soared to record highs yesterday. Last week's election is one factor. The stock market closed out the week with the worst day of the year so far. This trade war continues to wreak havoc on markets, and Wall Street is sending real signals about the sell-off. Incredible numbers here. Comes just hours after President Trump announced a 90-day pause on tariffs for many countries.

3:57The S &P 500 major over the past two days has shed over$5 trillion in value. Okay, that is the worst that we have seen since COVID. All those zigs and zags of the stock market have been unsettling to many investors. But they've also helped fuel the rise of a special kind of investment vehicle, structured products. In the simplest terms, structured products are effectively a debt security. That's Sam Potter, who edits Bloomberg's markets coverage. Structured products or structured notes are complicated financial instruments, a hybrid between a historically low-risk bond and a higher-risk derivative, like a stock option or future.

4:40So combining the best of both worlds. They're often pitched as a smart way for investors to hedge against risks when the market outlook is more volatile, like it is now. Structured products had fallen out of favor in the U.S. in the wake of the 2008 financial crisis. When Lehman Brothers collapsed, billions of dollars worth of structured products were wiped out along with it. But nearly two decades later, structured products are back. Last year, the American market for these products was worth nearly$200 billion, a record high. And this year, it's on course to be even bigger. People are looking for an alternative way to grow their wealth and also protect it.

5:24It's a shift Bloomberg Equities reporter Yi Chin Shen has been tracking with interest. Remember, these structured nodes, they function like a bond for most part, but they are not a bond. And that's the catch. I'm Sarah Holder, and this is The Big Take from Bloomberg News. Today on the show, the rise of structured products. In a volatile market, the investment vehicles are being marketed as a winning bet. But the reality is more complicated.

5:59Structured products are complex by design. So I called up Yiqin Shen to help me understand how they work. I am a reporter on the equities team, so I cover arbitrage trades and all things complex. Structured products, also known as notes, are designed to combine the rewards of investing in stocks with the security of investing in bonds. It's a hybrid instrument, so it is a bond with an option twist. Part of the product functions a lot like investing in a bond. You're supposed to get fixed returns over time. But the other part of the product functions more like an investment in the stock market.

6:40The derivative or the option part is what makes things really spicy up. Because now that you have your return linked to some other asset, it could be an index, a stock, or a basket of that. So that's what makes it a hybrid instrument, with a twist. By combining these properties, they're supposed to offer investors all the safety of a bond, but with higher returns. But those returns depend a lot on the performance of the asset they're linked to. There are a bunch of different kinds of structured products, but the most popular version is known as an auto-callable. They make up more than half of the structured products on the market right now.

7:20When you buy an auto-callable, you invest in a product's performance over a certain amount of time. Say, four years. So an example would be an auto-callable that is linked to S &P 500. At fixed dates throughout the term of your investment, say every quarter, you can collect a certain amount of money in coupons, just like a bond interest payment, provided the underlying asset performs in just the right way. As long as S &P 500, the underlying, stays within a certain range, then you will get your coupons. And by the end of the note ends, you will get your money back, the principal back. The extra twist with an autocallable is if on one of those dates, the value of the S &P is over a certain threshold, say a gain of 10 % from its starting level, the term of the investment automatically ends early.

8:15If, you know, the market goes really well and the S &P jumps more than 10%, you'll not well get called back earlier. Meaning even if you'd bought a four-year structured product, the deal is over. The issuer cashes you out. But that's still not bad, right? Because you get your money back, some coupons. Now, you might not make as much money as you would have if you just invested directly in the S &P. But you can still theoretically earn a decent return without taking on as many risks as you would have betting on stocks. And usually what happens is that people with their proceeds back reinvest. One reason people reinvest, especially when things are volatile, is because the underlying investment doesn't have to perform that well for you to get paid.

9:01So as long as it stays below that ceiling, you get your coupons. You don't want it to outperform, but you also don't want it to underperform. Because in an autocallable, there isn't just a ceiling. There's also a floor. The worst case will be if the market really flops and it drops below a certain floor. It could be usually 30 % to 40%. That's where you started to lose money. And by that time, there's no limitation how much you would lose. You lose as much as the market suffers. Got it. So in an autocallable, you're getting your coupons, everything's going well, unless something horrible happens and you might lose a lot of money.

9:44Yeah, exactly. There's another way to think about it. You can picture two options. One is that, okay, you stand under a solid roof. That's like buying a typical bunk. You get very steady, solid return, very safe. Or compared to you can buy and carry an umbrella. That's like buying a structure note. So with that umbrella, you can now go out and walk around. Walking around outside under your structured product umbrella might be less cozy than staying home, but it gives you more chances to make returns. In this universe, pretend buying that umbrella gives you the opportunity to collect a$5 bill on the sidewalk every few blocks.

10:30When the weather is decent, you know, everything's good. You get the returns and even if it gets a bit windy, that's totally fine. But the real test is when a storm hits. A storm being a market crash or an extreme dip in stock performance. That's where your umbrella fill up and, you know, you get soaked and the money blows away. So that's the worst case and you suffer. So if you want to be really safe, just live in your house. But if you want to take on a little bit of risks, have the opportunity to make a little bit more money. You can buy the umbrella. You can buy the structured note. roam free and hope that a big storm doesn't come.

11:12Exactly.

11:16This is the whole pitch behind buying a structured product. Your upsides might be capped, but at least your downsides are capped too. Unless, of course, the big storm hits. They're marketed as hitting the sweet spot between safety and speculation. That's Sam Potter, a senior editor with the markets team at Bloomberg. And he says that's why structured products tend to sell well in moments when the markets feel unpredictable and investors are uncertain. Moments like now. When valuations get very lofty, people get nervous, especially when you've got kind of trade war situation, a lot of geopolitical tensions and unpredictable administration in the White House.

11:59People don't want to eschew the chance for more returns, but equally they don't want to have everything at risk and they see structured products as a way to maybe have a little bit of security on their principal, but still get the returns. So I'm not surprised at all that the interest has picked up. They've always been big in Europe and in Asia, but finally catching hold in the US. Last year, financial firms sold a record$194 billion worth of structured notes to American investors. This year is expected to top that. And not just because people are feeling uncertain, but because banks see that uncertainty as an opportunity.

12:41If managed correctly, effectively, people are buying these notes and they don't tend to sell them off. There's rarely a secondary market. So it's a form of sticky capital for banks to get, good deposits to have. Selling structured products can help banks bring in more fees while capping the amount they have to pay investors. But for the investors themselves, there are more risks lurking in the fine print. That's after the break.

13:09Support for the show comes from Public.com. If you're actively involved in your portfolio, you probably catch yourself repeating the same actions. Buying the dip, manually sweeping idle cash, putting on a hedge. On public, you can now create AI agents that handle all these tasks on your behalf. Just describe what you want to do in plain English. Like, if the VIX hits 25, buy a put option on the S &P 500. Or, if my cash balance goes above$20 ,000, move the excess into my direct index. You approve of the workflow and your agent handles the rest. Monitoring the market, watching for your conditions, and executing your strategies exactly as defined.

13:48An investing platform driven by your intent, not just your clicks. You can also get full read and write access to your account via the public API. Go to public.com slash market and fund your account in five minutes or less. That's public.com slash market. Paid for by Public Investing. Brokered services by Open to the Public Investing, Inc., member FINRA and SIPC. Advisory services by Public Advisors, LLC, SEC Registered Advisor. Complete disclosures available at public.com slash disclosures. The thing about AI for business, it may not automatically fit the way your business works. At IBM, we've seen this firsthand.

14:28But by embedding AI across HR, IT, and procurement processes, we've reduced costs by millions slash repetitive tasks and freed thousands of hours for strategic work. Now we're helping companies get smarter by putting AI where it actually pays off. deep in the work that moves the business. Let's create smarter business, IBM. Let's talk about healthcare for a second. It doesn't always work the way people expect it to. If you've ever waited on a prescription refill or had a hard time getting the care you needed, you know the feeling. The system should just work better for everyone. That's exactly what the people at Optum are trying to do every day.

15:06They're a healthcare company linking patient care and pharmacy services and using data and technology to drive the whole system So care is connected, not complicated, for patients and providers. Things like making it easier to get care that looks at the whole person, from primary care doctors to mental health support and even in-home care, and then using technology to make sure they all work together. Technology designed to help doctors spend less time on busy work and more time with their patients. And those prescriptions? Optum is working to bring costs down, save patients money, and make it easier to get refills.

15:40Little by little, Optum is helping make healthcare work as one for everyone. Head to business.optum.com to see how.

15:53Recently, retail investors have started parking more of their money in special investments called structured products. The pitch is simple. If investing in the stock market is too risky and investing in bonds is too vanilla, structured products could be just right. But Bloomberg Markets editor Sam Potter told me they might not be right for everyone. The simple risk is just a complexity. Do you really understand the risk profile of what you're taking on? I mean, we've talked about kind of quite simple examples, something that's just tied to the range of the S &P 500, but the notes can get really complicated.

16:31You could bring in another couple of indexes and say the lowest of this is the range that we're going to use. And we're going to use these set dates for measurement. So the first thing is just the sheer complexity. The second thing is understanding the fees. You pay the fee up front in the price of the product, which is unlike something like an ETF, which has an ongoing fee. So do you really understand if you're getting your value for money? Often, Sam says, the answer is no. Plenty of people invest in structured products without fully understanding them. They've earned the nickname Boomer Candy because of how popular they've gotten with a particular kind of wealthy retiree.

17:10Someone with money to spare and a higher appetite for risk. I think the danger is the complexity maybe does obscure the risk that could be underlying these things. Those risks include the possibility of losing more than you bargained for in a market downturn, or of paying too much to make a bet that could turn out to be bad. And there's another, more fundamental risk, that even if the bank has essentially guaranteed you'll get your principal investment back, your bank could fail, and you could lose everything. It was a manic Monday in the financial markets. Lehman Brothers, a 158-year-old firm, filed for bankruptcy.

17:55Lehman in particular stands out because in the last year or so of its operation, it was struggling to raise money elsewhere. And so it actually ramped up the production and sales of these structured notes. It was already a big issuer. But in that last year, As I understand it, it really ramped up production of its structured notes in order to bring more money into the bank. As Lehman struggled to raise money, it started leaning more into structured products. And funnily enough, lots of those products that were sold were principal protection notes. So actually a lot of them were even named, you know, 100 % principal protection tied to S &P 500 or words to that effect.

18:40100 % principal protection, which means in theory, 100 % of that initial investment would be paid back, as long as that note was held to maturity. And they sold a great deal of them in the last year before everything finally collapsed. And what happened when Lehman collapsed in 2008? What happened to everyone who had bought those structured notes? I mean, effectively, what they were told in the aftermath was these things are now worthless. So you've lent your money to the bank, the bank has gone under. And actually where structured products tend to sit in the hierarchy of people who can get money out of a bankruptcy is pretty low.

19:16I do believe that there were many years of litigation that followed the Lehman collapse and more than 10 years of litigation we're talking. And some of those structured product owners did get some of their money back. But billions of dollars were wiped out and a lot of people didn't get repaid. Sam says the Lehman incident really tarnished the reputation of structured products in the U.S. It really set the market back. And it has really been until this decade it's taken to recover. You can go back and trace the market and the growth is very anemic. After Lehman Brothers, it falls off and then it's very, very slow to come back.

19:53And it's only really kind of 2021 onwards that it's really begun to take off again. And I guess people required that time and distance to put the past behind, but also the circumstances, as we just discussed, of high asset valuations have kind of rekindled an interest in the notes. These products are only as strong as the institution that backs them, which is one reason why, unlike in some other parts of the world, they're heavily regulated in the U.S. Depending on what the underlying asset is and who distributes it, a structured note could be regulated by the SEC, FINRA, and the CFTC. Another reason for all the oversight?

20:35Structured notes are increasingly sold to individual investors. While hedge funds and sophisticated money managers can and do buy structured products, many are able to create the same exposures on their own. Here's equities reporter Yichin Shen. If you are savvy enough, you can package those products on your own. Because it is a bond, right? To break it down fundamentally, it's a bond and an option package. You can just go to the market and create or replicate some similar option package without paying your bank or going through the middleman to give you advice, right? And you know exactly what the payout is going to be.

21:19But for everyone else, there's a broader lesson to take away from this. You might want to tread a bit more carefully when you're sold something with this much fine print. You should see the sheets that come with these things. It's like a financial contract and it's got all the small print. And any time Wall Street cooks up something complicated, I think people should be certainly careful about it.

21:45This is The Big Take from Bloomberg News. I'm Sarah Holder. To get more from The Big Take and unlimited access to all of Bloomberg.com, subscribe today at Bloomberg.com slash podcast offer. If you like this episode, make sure to follow and review The Big Take wherever you listen to podcasts. It helps people find the show. Thanks for listening. We'll be back tomorrow.

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