(Bloomberg) -- Wall Street’s printing press for complex investment products is having a blockbuster year, minting fees for bankers, hedge fund managers and ETF issuers.
Yet a slew of these newfangled strategies are struggling to wow — despite healthy demand — in a world where plain and simple bets on the S&P 500 keep winning big, again and again.
In the esoteric industry of structured products, for example, only 62% of the 1,080 newly launched quant-powered investing styles — riding a variety of multi-asset trades including relative value and trend following — showed positive performance through early December, according to data provider Premialab.
Despite the popularity of leveraged exchange-traded funds this year, about a third of such strategies are in the red, underscoring the challenge of market timing and the cost of taking short positions.
Meanwhile, the jury is still out on the efficacy of derivatives-heavy trades that are enjoying something of a revival like portable alpha, which give investors a way to ride the stock rally while spreading out their market wagers along the way.
Alternative investments like these offer a canny opportunity for investors to diversify their portfolios, at a time when the concentrated stock market is at the mercy of Big Tech companies like never before. Yet like many things in life, complexity doesn’t guarantee better outcomes. At least for now. Cheap index-tracking products riding large-cap companies are minting money across the board, given the S&P 500 is up a sizzling 27% this year and counting.
“Simple wins the day,” said Bradford Long, chief investment officer at Fiducient Advisors. “When risk is on, investors are more willing to enter into things that are a little less plain vanilla — exotic or fancy pants, if you want to call them that.”
From leveraged single-stock ETFs targeting small-fry investors to systematic trades touted for big institutions, the list of intricate — and high-fee — offerings is only multiplying. While some of today’s wonky strategies seek to capitalize on the gambling spirits of the YOLO crowd, many are designed to buffer losses or diversify from a concentrated market, among other things.
“Both fear and greed are spurring further product development,” said Eric Uchida Henderson, chief investment officer at East Horizon Investments. “Innovation in finance has always been robust, but we’ve seen significant acceleration in recent years.”
Take portable alpha and a related strategy known as equity extensions, two investing styles that fell out of favor after misfiring in the global financial crisis. By using borrowed money, the idea is that investors can wring out extra returns across traditional indexes of stocks and bonds.
Interest in a new variety of products aping the strategy is picking up. US funds focused on equity extensions drew $1.5 billion of fresh money over the last three quarters, poised for the largest annual inflows since 2009, the latest Nasdaq eVestment data show.
Newfound Research and ReSolve Asset Management have launched five portable alpha-inspired ETFs in a rebranded “return stacking” umbrella since 2023, including two this year. Together, these funds have amassed more than $800 million in assets.
These kind of diversified allocation processes may pay off in the event that big-name equity indexes struggle to post outsize gains in the years to come. But for now, the benefit has yet to fully pan out as tech megacaps keep their grip.
Strategies in the extension category returned 19% on average this year through September, eVestment data show. That’s respectable but those with a glass-half-empty disposition may point out that it’s some 3 percentage points behind the S&P 500 — an index that, barring a rout in August, has been relatively calm this year.
The return-stacking funds are designed to reap benefits over the long run. Still, the enduring rally of capitalization-weighted stock benchmarks continues to enrich the buy-and-hold faithful, making life harder for those preaching the virtues of diversification.
Three of the funds treat stocks as their core holdings and all are trailing the S&P 500 this year. The other two are anchored on bonds, both mired in losses.
Weighing on the performance are trend-following and multi-asset carry strategies, things that are meant to provide diverse returns from the core but are having a tough year, according to Corey Hoffstein, chief investment officer of Newfound.
“Our funds did pretty much exactly what we designed them to do. It’s just that the strategies we stacked on top had negative returns this year,” he said. “One of the nice things about return stacking, at least in our opinion, is that the return decomposition should be transparent.”
All told, the explosion in complex products reflects Wall Street’s never-ending hunt for the big “new angle” to stand out in the crowd amid intensified competition and demand for vehicles to ride the hottest trends of the day, according to Andrew J. Feldman, president at AJ Feldman Financial.
This year’s new angle in the ETF world at least: Products that double down on some of the best-performing assets, including tech stocks and crypto. That’s no sin. But the advice from pros: Vanilla allocations to the stocks should remain a core part of portfolios, and investors — particularly within the retail community — should be mindful of the financial industry’s clear incentive to hawk often high-fee products.
“Many providers are coming up with ideas and seeing if they work in the market, knowing that if they have one successful product, it can offset ones which are not successful,” Feldman said.
