Season Investments


Having Your Cake & Eating It Too

Posted on October 3, 2017

“Rule #1: Never lose money. Rule #2: Never forget Rule #1.” – Warren Buffett

2017-10-03_Cake.jpgWouldn’t it be nice if we could all invest according to Buffett’s rules? Unfortunately, the reality of investing is that it is next to impossible to “never lose money.” Mr. Buffett knows this better than most as he personally lost an estimated $23 billion during the Global Financial Crisis (GFC). In order to generate returns in excess of the risk free rate (think FDIC insured savings accounts at banks which are as close to “risk free” as you can get), one will have to take on some degree of risk, which could lead to a loss of principal. As the saying goes, “you can’t have your cake and eat it too.” Or can you?

A couple months back we received an email from a broker in NY soliciting an investment in something called a “structured product.” The easiest way to think of a structured product is as a contract between two parties, typically an investor and a bank, where the investor hands over money on the front end in exchange for a contracted return and term.

Our first instinct when we receive these types of emails is to simply delete them, but this one caught our attention for a variety of reasons. The broker was offering a 5 year CD with FDIC insurance that was tied to a multi-asset, trend following index developed by Goldman Sachs (GS). The product was a 5 year CD that offered 2x the total return of the index with a full return of principal if the underlying index happened to be underwater over the 5 year span. On the surface, it sounded like a great investment that incorporated many of our core beliefs of trend following and downside protection.

Our first thought was What’s the catch? With our curiosity peaked, we decided to follow up and learn more about the product. Here is what we learned:

  • Goldman Sachs developed the underlying trend-following index, called Momentum Builder, which invests in 14 different ETFs and cash to gain exposure to various global stocks, bonds, and hard asset investments.
  • The index is measured and updated daily based on the momentum and volatility of the 14 different ETF constituents.
  • For every dollar invested into the product, the vast majority (90%+) goes toward purchasing a 5-year, zero coupon US Treasury note to ensure the full return of principal at maturity. The remainder of the cash goes toward purchasing 5-year call options on the Momentum Builder index and paying fees/expenses.

The combination of the zero coupon bond with the call options is how GS is able to deliver 2x upside with no downside. Understanding how the product was structured in order to deliver the promised returns, made us much more comfortable in considering it as a potential investment. We looked at a mix of live and back tested returns going back to the middle of 2008 to see what an investor might have made if the product existed back then and was held for the full 5 year term. All of the five year return streams were positive, including those of mid-2008 vintage, and ranged from 6% - 14% annualized. We took these results with a grain of salt since they are theoretical and based on some back-tested data, but it was encouraging none-the-less. 

We also looked at the mix of exposure to stocks, bonds, hard assets, and cash over time. Goldman Sachs has a slightly different naming convention than us, but the chart below shows the ebb and flow of exposure to the various asset classes going back to mid 2008. We can see that throughout the GFC, the index would have held a significant amount of cash (around 50%) and fixed income/bonds (around 40%). It then shifted into equities/stocks and “alternatives” (which includes real estate and preferred stock) once the trend had been re-established in late 2009/early 2010.


The next question we asked was How does everyone get paid? As we all know, Wall Street is always out to make a buck so it is important to know how they are going to make money on this type of product. The answer to the question was multi-faceted.

  • First off, around 1%-2% of the amount invested comes off the top in fees to pay GS and the executing brokers. In our situation, the executing brokers would be the shop that initially contacted us and Schwab’s bond desk, since we custody our client accounts there.
  • Additionally, the index is built on an excess return basis, which nets out 3-month LIBOR + 0.65% as a “cost of hedging.” In other words, if someone was going to replicate this index, they would have to actively monitor and trade the 14 different underlying securities on a daily basis. If Goldman’s traders can hedge their exposure for less than 3-month LIBOR + 0.65%, then Goldman pockets the difference.
  • Lastly, Goldman does offer a price at which they will purchase these securities back from the investor prior to maturity. This price is typically less than the return of the underlying index. Based on some actual prices we saw on historical notes, it is safe to say that the “secondary market” is priced at a 5%-10% discount to the underlying index. In cases where investors sell back to Goldman prior to maturity, Goldman again profits from the spread.

In summary, some structured products can provide compelling investment opportunities depending on how they are structured. The things we really like about this particular one is how it is tied to a diversified, trend-following index, it is a total return (e.g. inclusive of dividends and interest) index, and it is in a CD wrapper which is FDIC insured up to $250k per CD. That being said, even this unique product is not without risk. The two primary risks to consider when looking at these types of investments are 1) illiquidity: don’t buy it unless you can hold it for the full term & 2) inflation: even if you get all your money back in five years, inflation will have eroded some of the purchasing power of that capital. But these risks are minimal in comparison to the potential upside with pretty close to a guarantee on fulfilling Buffett’s first two rules of investing (don’t lose money!). For that reason, we are strongly considering this structured product as a part of our diversified portfolio of investments.

elliott_headshot_bw.jpgAuthor Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.

Subscribe to our Weekly Insight via email!


Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.