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An RIA Who Uses Structured Notes to Invest in Global Banks

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Jerry Verseput believes in structure. The former engineer, now head of Veripax Financial Management, the RIA he founded in 2006, looks on the way investments are structured as opportunities, and among those opportunities are the risks in global diversification.

Verseput’s firm definitely favors a hands-on approach, and its website advises visitors that “Changing conditions must be analyzed and understood for their effect on investments and strategies, which lends itself well to an engineering-influenced style (some would call this being a ‘financial geek’).” And among the factors Verseput’s firm considers in its hands-on management of clients’ assets is increasing globalization. That has led to opportunities that take advantage not only of different countries’ economic cycles, but also the volatility that pays off in more complex investments.

“With Europe threatening recession and China’s economy slowing down, the international picture has a lot of uncertainty,” he said. While volatility has been “next to nothing in the U.S. the last couple of years” but in Europe has “kicked up,” leading some to avoid the region, Verseput said that very volatility has led to more opportunities.

Describing current market conditions as in the midst of a “long-term demographic shift, where the U.S. is not going to be the only economic hub in the world, particularly with some of the emerging markets,” Verseput said, “we’re going to have to move more and more to … a global focus as opposed to staying in the U.S.”

And in the last year, the volatility in Europe that has frightened off some investors has presented opportunities through what he said are “the right type of investments.” For Verseput, that’s been “structured notes—and specifically absolute return barrier (ARB) notes.”

Verseput’s view of investing and asset classes is definitely a more technical approach than one finds every day. He looks at equities as basically “one asset class, whether the stock is in the U.S. or Europe or in emerging markets,” because international companies play such a large role in both the S&P 500 and, say, the Euro Stoxx 50. “If you look at the Euro Stoxx 50, you’ve got Siemens, Bayer, Daimler—international companies just like the international [companies] in the S&P. They’re not all that different; having developed country foreign exposures is not all that different than having U.S. exposures. There’s no reason just to focus on the U.S.”

Instead, Verseput focuses on the aforementioned ARB notes, “senior debt obligations of global banks.” He said, “Right now, when you look at Europe facing recession, a lot of times stock drops when it faces recession and when [an economy] declares recession you’ve already hit the bottom.” ARB notes “provide leveraged upside, which will be great if the ECB follows through on some form of quantitative easing, and they provide positive returns at expiration on the downside up to a ‘barrier’ limit, which these days is typically around -40%. To me, it’s a great way to have exposure while hedging away a significant amount of downside risk, although if the market is down more than 40% in five or six years I’ll be sad.”

When volatility increased in Europe, he said, he turned to structured notes from Credit Suisse that are based on the Euro Stoxx 50, which offer returns of 1.5 times the return of the index on expiration. Should the index go down, the ARB notes will pay the inverse of the return up to a 40% drop. “I would never just invest with no downside protection in Europe right now,” he said, adding, “As an advisor whose primary job is to take different forms of risk and turn that into return, in this case I’m able to turn a whole bunch of market risk into a little bit of credit risk.” He’s also turned to income notes that provide dividends and are “tied to an index but with a huge downside buffer.”

That’s not to say that he confines himself to ARB notes; he also uses ETFs and bond funds. “Without really intending to, I’ve ended up adopting more of an endowment type of model,” he said. Illiquid alternatives make up 20–30% of the portfolio, with another 40–45% into long stocks. Of the long stock holdings, maybe 30% is foreign.

Verseput doesn’t restrict investments to Europe, although he doesn’t seek out individual countries—or individual stocks. “If I’m doing an emerging market fund, I will use an equity fund instead of ADRs. I leave those to the guys who study foreign markets 24 hours a day.” But both ETFs and bond funds bring emerging market exposure to client portfolios.

Veripax’s investment strategy points out, “Owning a handful of mutual funds that all buy stocks does not get the job done in a globalized and highly interconnected economy. It is also vitally important to minimize large losses, even if you have a long way to go before retirement.” And Verseput sticks to that strategy, regardless of where in the world he places his clients’ assets.

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