Ben Felix - Are Structured Products Good Investments?

Short Summary

Main recommendation: most investors should avoid structured notes most of the time, because they tend to be overpriced, increasingly so as complexity rises, and typically underperform simple, low-cost portfolios of stocks and bonds. Ben Felix argues that the appeal of their headline features (high coupon yields and downside protection) hides costs and risks that are hard for most investors to evaluate. He allows that some niche cases might make sense.

Key Points

• Structured notes are senior unsecured debt securities whose payoffs are tied to an underlying asset such as a stock, a basket of stocks, or an index, and they come in many variants, including principal protected notes and yield enhancement products.
• Research cited in the video found structured notes overpriced relative to estimated fair value, for example about 8% above fair value for one popular retail product and roughly 4.5% to 6.5% overpricing for two other note types.
• A 2021 study of over 28,000 yield enhancement products found attractive yields but negative returns, with total annual costs to investors of about six to seven percent (most having negative expected returns net of fees); simple combinations of the underlying asset and listed options dominated them.
• A 2017 study found that higher headline rates, complexity, and risk were positively correlated with bank profitability, and that banks targeting less sophisticated clients offered the most complex products.
• Investor biases, such as aversion to losses, overestimation of crash probability, and desire for upside, make the protection and upside features appealing while risks are neglected.
• Structured notes often pay higher commissions to the selling broker or advisor, so Felix advises asking any advisor about conflicts of interest before accepting a recommendation.

Details Worth Noting

• Concrete instructions: Before buying any structured note, ask the advisor whether they have a conflict of interest, since these products often pay higher commissions than simpler, lower-cost alternatives. Compare the product against a simple combination of the underlying asset and listed options, or against a low-cost portfolio of stocks and bonds, since the cited research found those alternatives frequently outperform. Make sure you can assess the product's costs, risks, and expected returns; if you cannot, Felix suggests treating that as a reason to avoid it.
• The video says structured notes can be tax inefficient and illiquid, in addition to their cost and return drawbacks.
• Felix cites Meir Statman's distinction between an error (not knowing the trade-off you are making) and a want (knowing the trade-off and proceeding anyway). He says some investors may knowingly accept high costs for a specific payoff, but he thinks most buyers are simply unaware of the costs, risks, and expected returns.
• A 2020 study cited in the video suggests U.S. broker dealers may push up prices of the underlying structured products on the issue pricing date, raising costs for buyers.
• A 2023 study cited found that markups are partly explained by information asymmetry between issuers and investors, and that issuance rises when that asymmetry is higher.
• Felix notes that the research described is from academic studies, and that a few people selling structured products have tried to make the case for them to him, which he has not found convincing.

Bottom Line

Structured notes are complex, costly products whose attractive headline features tend to mask weaker expected outcomes, so they are generally a poor choice for most investors, though the video leaves room for rare exceptions.