There’s a New (and Cheaper) Way for Clients to Borrow Against Their Portfolios

“Our solution takes an alternative approach to traditional portfolio borrowing through listed derivatives,” Sood explained. “Advisors can generate sample borrowing terms showing indicative rates in seconds — no banks, no credit checks, no forced sales of securities.”

As Sood detailed, Vest has been using the mechanics behind Synthetic Borrow for several years as it has launched and maintained its existing buffer ETF strategies. Over time, the firm’s leaders started to see serious potential in making the underlying technology and expertise available for public use.

“In that sense, this isn’t really a new solution, because we’ve been doing this internally for a number of years now,” Sood said. “There are some funds that we manage in which we have to borrow from time to time. Well, we don't go and borrow from a bank. We borrow through this synthetic style of borrowing, and now we’re making that capability available to the marketplace.”

The Vision

Sood likened the strategy to Amazon’s delivery of the AWS cloud computing platform.

“Amazon first built out AWS in order to power their own business,” he explained. “Eventually they saw the huge opportunity of opening up that system for public use, and now AWS is a massive part of their business. We’re hoping and expecting that Synthetic Borrow can have a similar trajectory.”

Sood said the benefits of the strategy include many of the features associated with traditional portfolio financing, including the ability to keep portfolios fully invested while accessing upfront liquidity. One big differentiator, he said, is the ability to lock in fixed, market-based rates upfront — allowing clients to avoid floating-rate uncertainty associated with pledged asset lines or margin loans.

“The traditional financing solutions are left wanting,” Sood said. “Variable rates create uncertainty, credit checks delay access, and it all can result in sub-optimal outcomes. What we’re doing is totally different. It’s really about utilizing implied financing available in the listed derivatives markets and delivering it for easy access through a tech-enabled platform. In our view, portfolio financing should have been this efficient all along.”

How It Works

As Sood described, Synthetic Borrow starts with the creation of a box spread. That's essentially a multi-option strategy that combines a bull call spread and a bear put spread with the same strike prices and expiration dates — built to profit from a difference in pricing between the options and their theoretical value.

“We create a short box spread option strategy that combines a short call spread with a short put spread,” Sood explained. “This is designed to provide a fixed amount of cash now in exchange for a fixed repayment later.”

Once the box spread is in place, a client gets the borrowed amount upfront as cash. This comes from the net premium collected on the combined options positions. As Sood detailed, this amount is essentially the fixed value of the spread, adjusted by the market's implied interest rate.

Finally, clients repay the loan at expiration. That is, when the options expire, the user repays a fixed amount based on the difference between the strike prices. In practice, this works like paying back a loan’s principal plus interest, and the implied interest rate built into the box spread is reflective of the cost of the synthetic loan.

Vest is compensated by charging a fee, currently set at 0.95% per annum on the “borrow” amount.

Sood said this strategy can deliver significant savings for the typical user, reducing the effective interest rate on the loan by half or more.

Mind the Risks

While expressing optimism about Synthetic Borrow effectively serving clients who want liquidity without selling assets in their long-term portfolios, Sood also noted that the solution does come with risks.

“The first risk, I would say, is that clients could get into a strategy they don’t fully understand, and that’s always a hurdle to get over when it comes to utilizing more complex strategies like derivatives, options, puts, etc.,” Sood said.

“That’s why we really put a lot of effort into advisor education, and to be clear, we think this is a product that is best used by professional advisors who already have some familiarity with the risks and rewards associated with derivatives," he added. "Advisors with this expertise are poised to deliver a ton of added value to their clients through Synthetic Borrow.”

Likewise, there are structural risks and tradeoffs to be aware of, Sood said.

For example, the box spreads used in the Synthetic Borrow strategy have a fixed payoff at a future date, making them economically similar to zero-coupon bonds. The short box spread used in the strategy is subject to interest rate risks, meaning that its mark-to-market value may fluctuate as interest rates and broader market conditions change.

While the final payoff of the box spread is fixed, interim valuations can move in response to shifts in rates. As such, the ability to purchase or sell box spreads effectively is dependent on the availability and willingness of other market participants to transact in box spreads at competitive prices.

If the box spread is closed or downsized before expiration, the payoff amount owed by the client may be different than the fixed payoff at the original expiration date. This could cause the client to realize a higher implied borrowing rate than the amount that was in place at the original expiration date.

Another consideration is market risk. The amount of net premium, early repayment amount (if applicable), borrowing rate and duration available will differ in future market conditions, and there is no guarantee that the same terms will be available to any client seeking to use this strategy.

Similar to a pledged asset line, there is also margin and repayment risk in the case of a major market downturn. This is because short box spreads require margin approval and may require significant collateral. If the value of a client’s collateral account falls below the minimum maintenance requirements set by the custodian, a margin call may be issued by the custodian.

Finally, clients must consider use of the Synthetic Borrow solution in the context of their aggregate margin risk, and there is no guarantee that Vest will be able to execute a box spread transaction on any given day or at anticipated pricing levels.