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

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<v Speaker 1>Bloomberg Audio Studios, podcasts, radio news.

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<v Speaker 2>The FED cut interest rates by twenty five basis points

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<v Speaker 2>Wednesday and signaled that two more cuts could be coming

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<v Speaker 2>this year.

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<v Speaker 1>Where we got pretty much exactly what the market had expected.

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<v Speaker 2>In anticipation of the announcement, stocks had been climbing, but

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<v Speaker 2>then the news dropped.

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<v Speaker 1>But once people started parsing the dot plant and started

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<v Speaker 1>parsing what j Powell had to say, stocks flit back,

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<v Speaker 1>with the S and P, the Nasdaq ending in the red,

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<v Speaker 1>and a two percent rally in the Russell being almost

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<v Speaker 1>entirely erased.

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<v Speaker 2>Fetchaer. Jerome Powell got to the heart of the market's

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<v Speaker 2>concern in his press conference.

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<v Speaker 3>There are no risk free paths now.

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<v Speaker 1>It's not incredibly obvious.

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<v Speaker 3>What to do.

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<v Speaker 2>Inflation is still elevated, and the labor market is showing

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<v Speaker 2>signs of weakness. It's all keeping investors on edge in

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<v Speaker 2>what's already been a particularly tumultuous year.

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<v Speaker 1>The stock market here in the US sort of record

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<v Speaker 1>highs yesterday.

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<v Speaker 3>Last week's election is one.

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<v Speaker 2>Fact stock market closed out the week with the worst

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<v Speaker 2>day of the year so far.

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<v Speaker 3>This trade war continues to wreak havoc on market and

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<v Speaker 3>Wall Street is sending real signals about the sell off.

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<v Speaker 3>Credible numbers. Here comes just hours after President Trump announced

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<v Speaker 3>a ninety day pause on tariffs for many countries. The

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<v Speaker 3>S and P five hundred major over the past two

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<v Speaker 3>days has shed over five trillion dollars in value.

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<v Speaker 2>Okay, that is the worst that we have seen since COVID.

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<v Speaker 2>All those zigs and zags of the stock market have

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<v Speaker 2>been unsettling to many investors, but they've also helped fuel

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<v Speaker 2>the rise of a special kind of investment vehicle. Structured products.

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<v Speaker 4>In the simplest term, structured products are effectively at debt security.

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<v Speaker 2>That's Sam Potter, who edits Bloomberg's Markets coverage. Structured products

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<v Speaker 2>or structured notes are complicated financial instruments, a hybrid between

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<v Speaker 2>a historically low risk bond and a higher risk derivative

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<v Speaker 2>like a stock option or future.

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<v Speaker 4>So combining the best of both worlds.

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<v Speaker 2>They're often pitched as a smart way for investors to

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<v Speaker 2>hedge against risks when the market outlook is more volatile,

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<v Speaker 2>like it is now. Structured products had fallen out of

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<v Speaker 2>favor in the US in the wake of the two

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<v Speaker 2>thousand and eight financial crisis, when Lehman Brothers collapsed. Billions

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<v Speaker 2>of dollars worth of structured products were wiped out along

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<v Speaker 2>with it, but nearly two decades later, structured products are back.

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<v Speaker 2>Last year, the American market for these products was worth

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<v Speaker 2>nearly two hundred billion dollars, a record high, and this

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<v Speaker 2>year it's on course to be even bigger.

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<v Speaker 3>People are looking for an alternative way to grow their

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<v Speaker 3>wealth and also protect it.

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<v Speaker 2>It's a shift. Bloomberg Equities reporter ye Chin Shen has

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<v Speaker 2>been tracking.

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<v Speaker 3>With interest remembers these structure notes. They function like a

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<v Speaker 3>bond for most pot but they are not a bond,

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<v Speaker 3>and that's the catch.

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<v Speaker 2>I'm Sarah Holder, and this is the big take from

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<v Speaker 2>Bloomberg News Today. On the show The Rise of Structured

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<v Speaker 2>Products in a Volatile market, The investment vehicles are being

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<v Speaker 2>marketed as a winning vet, but the reality is more complicated.

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<v Speaker 2>Structured products are complex by design. So I called up

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<v Speaker 2>Yachin Sheen to help me understand how they work.

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<v Speaker 3>I am a reporter on the equities team, so I

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<v Speaker 3>cover Abigehres and Alstin's complex.

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<v Speaker 2>Structured products, also known as notes, are designed to combine

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<v Speaker 2>the rewards of investing in stocks with the security of

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<v Speaker 2>investing in bonds.

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<v Speaker 3>It's a hybrid instrument, so it is a bond with

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<v Speaker 3>an all hunts twist.

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<v Speaker 2>Part of the product functions a lot like investing in

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<v Speaker 2>a bond. You're supposed to get fixed returns over time,

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<v Speaker 2>but the other part of the product functions more like

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<v Speaker 2>an investment in the stock market.

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<v Speaker 3>The derivative of the auction pod is what makes things

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<v Speaker 3>really splicy of because now that you have your return

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<v Speaker 3>linked to some other assets. It could be an index,

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<v Speaker 3>a stock, or a boss code of that.

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<v Speaker 2>So that's what makes it a hybrid instrument with a twist.

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<v Speaker 2>By combining these properties, they're supposed to offer investors all

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<v Speaker 2>the safety of a bond, but with higher returns, but

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<v Speaker 2>those returns depend a lot on the performance of the

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<v Speaker 2>asset they're linked to. There are a bunch of different

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<v Speaker 2>kinds of structured products, but the most popular version is

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<v Speaker 2>known as an auto callable. They make up more than

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<v Speaker 2>half of the structured products on the market right now.

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<v Speaker 2>When you buy an autocallable, you invest in a product's

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<v Speaker 2>performance over a certain amount of time, say four years.

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<v Speaker 3>So example, what be a auto callable that is linked

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<v Speaker 3>to SMP five poundred.

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<v Speaker 2>At six states. Throughout the term of your investment, say

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<v Speaker 2>every quarter, you can elect a certain amount of money

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<v Speaker 2>in coupons, just like a bond interest payment. Provided the

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<v Speaker 2>underlying asset performs in just the right way.

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<v Speaker 3>As long as SMP five pondre the underlying stay wins

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<v Speaker 3>to arrange them, you will get your coupons, and by

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<v Speaker 3>the end of the null ends you will get your

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<v Speaker 3>money back the principle back.

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<v Speaker 2>The extra twist with an autocallable is if on one

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<v Speaker 2>of those dates the value of the SMP is over

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<v Speaker 2>a certain threshold, say again of ten percent from its

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<v Speaker 2>starting level, the term of the investment automatically ends early.

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<v Speaker 3>If you know, the market goes really well and the

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<v Speaker 3>SMP jumps walls and ten percent, you'll not well get

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<v Speaker 3>called back earlier.

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<v Speaker 2>Meaning even if you'd bought a four year structured product,

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<v Speaker 2>the deal is over. The issue werk cashes you out.

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<v Speaker 3>But that's not bad, right, because you get your money

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<v Speaker 3>back some couppoons.

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<v Speaker 2>Now, you might not make as much money as you

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<v Speaker 2>would have if if you just invested directly in the SMP,

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<v Speaker 2>but you can still theoretically earn a decent return without

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<v Speaker 2>taking on as many risks as you would have betting on.

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<v Speaker 3>Stocks, and usually what happens is that people wazir proceeds

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<v Speaker 3>back we invest.

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<v Speaker 2>One reason people reinvest, especially when things are volatile, is

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<v Speaker 2>because the underlying investment doesn't have to perform that well

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<v Speaker 2>for you to get paid. So as long as it

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<v Speaker 2>stays below that ceiling, you get your coupons. You don't

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<v Speaker 2>want it to outperform, but you also don't want it

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<v Speaker 2>to underperform, because in an autocallable there isn't just a ceiling,

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<v Speaker 2>there's also a floor.

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<v Speaker 3>The wolf case well be if the market really you know,

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<v Speaker 3>flops and it drops below certain flow, it could be

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<v Speaker 3>usually thirty to forty percent. That's where you started to

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<v Speaker 3>lose money. And by that time there's no limitation how

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<v Speaker 3>much you would lose. You lose as much as the

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<v Speaker 3>market suffers.

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<v Speaker 4>Got it.

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<v Speaker 2>So, in an autocullable, you're getting your coupons, everything's going well.

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<v Speaker 2>In less something horrible happens, then you might lose a

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<v Speaker 2>lot of money.

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<v Speaker 3>Yeah, exactly. There's another way to think about it. You

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<v Speaker 3>can picture two options. One is that okay, you stand

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<v Speaker 3>under a solid roof. That's like buying a typical bond,

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<v Speaker 3>you get very steady, solid return, very safe or compared

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<v Speaker 3>to you can buy and carry an umbrella. That's like

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<v Speaker 3>buying a structure note. So with that umbrella you can

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<v Speaker 3>now go out and walk it wrong.

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<v Speaker 2>Walking around outside under your structured product umbrella might be

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<v Speaker 2>less cozy than staying home, but it gives you more

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<v Speaker 2>chances to make returns in this universe. Pretend buying that

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<v Speaker 2>umbrella gives you the opportunity to collect a five dollars

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<v Speaker 2>bill on the sidewalk every few blocks.

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<v Speaker 3>When the weather is decent. You know everything's good, You

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<v Speaker 3>get the returns, and even it gets a bit of windy,

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<v Speaker 3>totally fly. But the real task is when a storm hits.

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<v Speaker 2>A storm being a market crash or an extreme dip

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<v Speaker 2>in stock performance, that's.

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<v Speaker 3>Where your umbrella phillips and you get sold and the

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<v Speaker 3>money blows away. So that's the worst case and you suffer.

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<v Speaker 2>So if you want to be really safe, just live

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<v Speaker 2>in your house. But if you want to take on

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<v Speaker 2>a little bit of risks, have the opportunity to make

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<v Speaker 2>a little bit more money, you can buy the umbrella.

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<v Speaker 2>You can buy the structured note, roam free and hope

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<v Speaker 2>that a big storm doesn't come exactly. This is the

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<v Speaker 2>whole pitch behind buying a structured product. Your upsides might

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<v Speaker 2>be capped, but at least your downsides are capped too, unless,

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<v Speaker 2>of course, the big storm hits.

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<v Speaker 4>They're marketed as hitting the sweet spot between safety and speculation.

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<v Speaker 2>That's Sam Potter, a senior editor with the Market's team

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<v Speaker 2>at Bloomberg, and he says that's why structured products tend

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<v Speaker 2>to sell well in moments when the markets feel unpredictable

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<v Speaker 2>and investors are uncertain.

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<v Speaker 4>Moments like now, when valuations get very lofty, people get nervous,

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<v Speaker 4>especially when you've got kind of trade war situation, a

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<v Speaker 4>lot of geopolitical tensions, and unpredictable administration in the White House.

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<v Speaker 4>People don't want to eschew the chance for more returns,

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<v Speaker 4>but equally they don't want to have everything at risk,

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<v Speaker 4>and they see structured products as a way to maybe

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<v Speaker 4>have a little bit of security on their principle, but

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<v Speaker 4>still get the returns. So I'm not surprised at all

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<v Speaker 4>that the interest is picked up. They've always been big

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<v Speaker 4>in Europe and in Asia, but finally catching hold in

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<v Speaker 4>the US.

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<v Speaker 2>Last year, financial firm sold a record one hundred and

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<v Speaker 2>ninety four billion dollars worth of structured notes to American investors.

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<v Speaker 2>This year is expected to top that, and not just

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<v Speaker 2>because people are feeling uncertain but because banks see that

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<v Speaker 2>uncertainty as an opportunity.

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<v Speaker 4>If managed correctly effectively, people are buying these notes and

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<v Speaker 4>they don't tend to sell them off. That's it rarely

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<v Speaker 4>a secondary market, so it's a form of sticky capital

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<v Speaker 4>for banks to get good deposits to have.

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<v Speaker 2>Selling structured products can help banks bring in more fees

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<v Speaker 2>while capping the amount they have to pay investors. But

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<v Speaker 2>for the investors themselves, there are more risks lurking in

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<v Speaker 2>the fine print. That's after the break. Recently, retail investors

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<v Speaker 2>have started parking more of their money in special investments

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<v Speaker 2>called structured products. The pitch is simple, if investing in

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<v Speaker 2>the stock market is too risky and investing in bonds

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<v Speaker 2>is too vanilla, structured products could be just right. But

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<v Speaker 2>Bloomberg Market's editor Sam Potter told me they might not

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<v Speaker 2>be right for everyone.

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<v Speaker 4>Risk is just a complexity. Do you really understand the

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<v Speaker 4>risk profile of what you're taking on? I mean, we've

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<v Speaker 4>talked about kind of quite simple examples. Something that's just

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<v Speaker 4>tied to the range of the S and P five hundred.

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<v Speaker 4>But the notes can get really complicated. You could bring

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<v Speaker 4>in another couple of indexes and say the lowest of

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<v Speaker 4>this is the range that we're going to use, and

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<v Speaker 4>we're going to use these set dates for measurement. So

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<v Speaker 4>the first thing is just the sheer complexity. The second

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<v Speaker 4>thing is understanding the fees. You pay the fee up

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<v Speaker 4>front in the price of the product, which is unlike

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<v Speaker 4>something like an ETF which has an ongoing fee. So

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<v Speaker 4>do you really understand if you're getting your value for money?

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<v Speaker 2>Often, Sam says the answer is no. Plenty of people

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<v Speaker 2>invest in structured products without fully understanding them. They've earned

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<v Speaker 2>the nickname boomer candy because of how popular they've gotten

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<v Speaker 2>with a particular kind of wealthy retiree, someone with money

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<v Speaker 2>to spare and a higher appetite for risk.

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<v Speaker 4>I think the danger is the complexity maybe does obscure

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<v Speaker 4>the risk that could be underlying these things.

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<v Speaker 2>Those risks include the possibility of losing more than you

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<v Speaker 2>bargained for in a market downturn, or of paying too

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<v Speaker 2>much to make a bet that could turn out to

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<v Speaker 2>be bad. And there's another more fundamental risk that even

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<v Speaker 2>if the bank has essentially guaranteed you'll get your principal

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<v Speaker 2>investment back, your bank could fail and you could lose everything.

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<v Speaker 3>It was a manic Monday in the financial markets.

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<v Speaker 1>Lehman Brothers, a one hundred and fifty eight year old firm,

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<v Speaker 1>filed for bankruptcy.

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<v Speaker 4>Leman in particular stands out because in the last year

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<v Speaker 4>or so of its operation, it was struggling to raise

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<v Speaker 4>money elsewhere, and so it actually ramped up the production

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<v Speaker 4>and sales of these structured notes. It was already a

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<v Speaker 4>big issuer, but in that last year, as I understand,

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<v Speaker 4>it really rempt up production of its structured notes in

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<v Speaker 4>order to bring more money into the bank.

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<v Speaker 2>As Leman struggled to raise money, it started leaning more

0:13:07.600 --> 0:13:09.200
<v Speaker 2>into structured products.

0:13:09.240 --> 0:13:12.360
<v Speaker 4>And funnily enough, lots of those products that were sold

0:13:12.480 --> 0:13:15.640
<v Speaker 4>were principal protection notes. So they actually a lot of

0:13:15.679 --> 0:13:18.000
<v Speaker 4>them were even named, you know, one hundred percent principal

0:13:18.080 --> 0:13:21.520
<v Speaker 4>protection tied to S and P five hundred or words

0:13:21.559 --> 0:13:22.199
<v Speaker 4>to that effect.

0:13:22.720 --> 0:13:27.120
<v Speaker 2>One hundred percent principal protection, which means, in theory, one

0:13:27.280 --> 0:13:30.120
<v Speaker 2>hundred percent of that initial investment would be paid back

0:13:30.640 --> 0:13:33.280
<v Speaker 2>as long as that note was held to maturity, and they.

0:13:33.280 --> 0:13:35.240
<v Speaker 4>Sold a great deal of them in the last year

0:13:35.320 --> 0:13:37.840
<v Speaker 4>before everything finally collapsed.

0:13:38.440 --> 0:13:41.080
<v Speaker 2>And what happened when Lehman collapsed in two thousand and eight,

0:13:41.120 --> 0:13:44.320
<v Speaker 2>what happened to everyone who had bought those structured notes, I.

0:13:44.360 --> 0:13:47.800
<v Speaker 4>Mean, effectively, what they were told in the aftermath was

0:13:48.280 --> 0:13:50.880
<v Speaker 4>these things are now worthless. So you've lent your money

0:13:50.920 --> 0:13:53.240
<v Speaker 4>to the bank. The bank has gone under. And actually

0:13:53.280 --> 0:13:56.040
<v Speaker 4>where structured products tend to sit in the hierarchy of

0:13:56.080 --> 0:13:58.680
<v Speaker 4>people who can get money out of bankruptcy is pretty low.

0:13:59.400 --> 0:14:01.520
<v Speaker 4>I do believe believe that there were many years of

0:14:01.600 --> 0:14:05.360
<v Speaker 4>litigation that followed the Lehman collapse, and more than ten

0:14:05.480 --> 0:14:08.320
<v Speaker 4>years of litigation we're talking. And some of those structured

0:14:08.360 --> 0:14:11.640
<v Speaker 4>product owners did get some of their money back, but

0:14:11.880 --> 0:14:13.959
<v Speaker 4>billions of dollars were wiped out and a lot of

0:14:14.000 --> 0:14:15.439
<v Speaker 4>people didn't get repaid.

0:14:16.160 --> 0:14:19.760
<v Speaker 2>Sam says the Lehman incident really tarnished the reputation of

0:14:19.800 --> 0:14:21.320
<v Speaker 2>structured products in the US.

0:14:22.080 --> 0:14:25.040
<v Speaker 4>It really set the market back, and it has really

0:14:25.120 --> 0:14:28.920
<v Speaker 4>been until this decade. It's taken to recover. You can

0:14:28.960 --> 0:14:31.200
<v Speaker 4>go back and trace the market and the growth is

0:14:31.360 --> 0:14:34.120
<v Speaker 4>very anemic. After Lehman Brothers, it falls off and then

0:14:34.200 --> 0:14:36.400
<v Speaker 4>it's very very slow to come back, and it's only

0:14:36.520 --> 0:14:40.200
<v Speaker 4>really kind of twenty twenty one onwards that it's really

0:14:40.240 --> 0:14:44.640
<v Speaker 4>begun to take off again. I guess people required that

0:14:45.000 --> 0:14:48.400
<v Speaker 4>time at distance to put the pass behind. But also

0:14:48.640 --> 0:14:52.680
<v Speaker 4>the circumstances as we just discussed of high asset valuations

0:14:53.240 --> 0:14:56.080
<v Speaker 4>have kind of rekindled an interest in the notes.

0:14:57.520 --> 0:15:00.120
<v Speaker 2>These products are only as strong as the institution and

0:15:00.200 --> 0:15:03.200
<v Speaker 2>that backs them, which is one reason why, unlike in

0:15:03.280 --> 0:15:05.960
<v Speaker 2>some other parts of the world, they're heavily regulated in

0:15:06.040 --> 0:15:09.200
<v Speaker 2>the US. Depending on what the underlying asset is and

0:15:09.360 --> 0:15:12.520
<v Speaker 2>who distributes it, a structured note could be regulated by

0:15:12.560 --> 0:15:17.520
<v Speaker 2>the SEC, FINRA and the CFTC. Another reason for all

0:15:17.600 --> 0:15:22.359
<v Speaker 2>the oversight, structured notes are increasingly sold to individual investors.

0:15:22.840 --> 0:15:26.360
<v Speaker 2>While hedge funds and sophisticated money managers can and do

0:15:26.680 --> 0:15:29.960
<v Speaker 2>buy structured products, many are able to create the same

0:15:30.080 --> 0:15:33.960
<v Speaker 2>exposures on their own. Here's equities reporter Yu Chinshen.

0:15:34.520 --> 0:15:39.560
<v Speaker 3>If you are savvy enough, you can package those products

0:15:39.600 --> 0:15:42.400
<v Speaker 3>on your own. Because it is a bond, right to

0:15:42.480 --> 0:15:46.320
<v Speaker 3>break it down, fundamentally, it's a bond and an auctum package.

0:15:46.800 --> 0:15:50.120
<v Speaker 3>You can just go to the market and create or

0:15:50.240 --> 0:15:55.600
<v Speaker 3>replicate some similar auctionum package without paying your bank or

0:15:55.760 --> 0:16:00.120
<v Speaker 3>going through the middleman to give you advice, right, and oh,

0:16:00.280 --> 0:16:02.000
<v Speaker 3>exactly what the payout it's going to be.

0:16:02.760 --> 0:16:05.720
<v Speaker 2>But for everyone else, there's a broader lesson to take

0:16:05.760 --> 0:16:08.360
<v Speaker 2>away from this. You might want to tread a bit

0:16:08.440 --> 0:16:12.480
<v Speaker 2>more carefully when you're sold something with this much fine print.

0:16:13.080 --> 0:16:15.240
<v Speaker 4>You should see the sheets that come with these things.

0:16:15.280 --> 0:16:17.600
<v Speaker 4>It's like a financial contract and it's got all the

0:16:17.680 --> 0:16:21.680
<v Speaker 4>small print. And anytime Wall Street cooks up something complicated,

0:16:21.760 --> 0:16:24.880
<v Speaker 4>I think people should be certainly careful about it.

0:16:28.360 --> 0:16:31.240
<v Speaker 2>This is the Big Take from Bloomberg News. I'm Sarah Holder.

0:16:31.560 --> 0:16:34.120
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0:16:34.200 --> 0:16:37.920
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0:16:38.000 --> 0:16:41.720
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0:16:41.880 --> 0:16:44.160
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0:16:44.240 --> 0:16:46.920
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0:16:47.840 --> 0:16:50.000
<v Speaker 2>Thanks for listening. We'll be back tomorrow