In Defense of Structured
With all the bad press that Structured instruments have received over the past few years, it is worth asking if they are likely to be with us for the long term. After all, Cramer declared war on them. And many commentators have rightly pointed out the following flaws with respect to various structured investments:
- too complicated
- hide fees
- encourage fraud
- obscure risks
- increase systemic leverage
But at the end of the day, we at DealVector believe Structured markets will remain resilient for two fundamental reasons. It’s just physics.
First, institutional investors need rated assets. Structured product tranching of pooled risk creates many more investable rated assets. We can argue about what the ratings should be. But those ratings are comprehensible, can be modeled, and are “risk-managable” in the minds of large institutions like pensions and insurance companies.Second, money managers and issuers benefit enormously from term leverage, which is otherwise generally unavailable to them, or available only at higher cost. For example, a manager wanting to launch a typical hedge fund needs to manage the risk of quarterly redemptions. This affects the portfolio decisions and the business decisions of an operator. The manager of a structured pool of assets gets multi-year locked funding and has no such concerns.
Future iterations of structured products will get better at dealing with the flaws listed above. In particular, better transparency must be a big part of the solution, especially with respect to deal terms, involved parties, liquidity, and counter-party risk. Such transparency will expand the market, and it is central to the DealVector mission.
But at the end of the day term funding and rated portions of asset pools are deeply desired by the finance ecosystem. Delivering these preferences to investors will lower the overall cost of capital in the economy. Despite Cramer, Structured is here to stay.
