If you are looking to manage your portfolio’s risk-return profile, why not join the growing number of investors who have been using structured notes?
Structured notes can be a great addition to your investment portfolio, allowing you to gain exposure to a desired market or index at an effective cost, and providing the added benefit of potential gains from any rise in that index.
A structured note is a great combination of pure investment (i.e., shares or bonds), and insurance that can provide downside protection in times of economic stress, while offering the potential for performance when the market is moving in the favourite direction.
In this article, we’ll explore the benefits of structured notes, how they work and who should consider them.
What are structured notes
A structured note is a financial instrument issued by an investment firm that has embedded derivatives to provide downside protection or upside participation to an underlying index or other reference assets, such as commodity prices.
Structured notes pay either a fixed or floating interest rate. They are issued by investment banks, insurance companies, and specialist structured product companies, such as Guggenheim Partners and Pacific Investment Management.
The value of a structured note is directly linked to the underlying asset and pays a fixed return if held to maturity under certain market conditions. If the market moves against the investor, there is potential to lose some of your initial investment.
Structured notes are a good idea for an investor who wants to protect his investment when the market crashes. They can protect his portfolio if something bad happens. But unlike options or futures contracts, most structured notes are not traded publicly.
How do structured notes work
Typically, a structured note has the following structure: the amount invested is used to pay for a derivative contract that references an underlying asset.
For example, if an investor wants to buy a stock market index at its current value, he might buy 100 shares of an exchange-traded fund (ETF) tracking it. On the other hand, he could buy a call option on the index or a futures contract.
Alternatively, an investor could consider buying an equity-linked structured note. This would give him direct exposure to the market without having to find 100 shares of an index fund and paying brokerage fees and taxes. The downside is that if he buys the stock market index with a structured note, he will not benefit greatly if it goes up.
On the other hand, if the market falls, the investor will not lose his entire investment. The embedded derivative contract provides protection for his portfolio.
Benefits of Structured Notes
Here are some of the benefits of structured notes
- Diversification of investments
- Market exposure without the risk of losing your shirt
- Added return potential with downside risk management
- High yield potential with low correlation to other assets such as treasuries and corporate bonds
Conclusion
Structured notes have several advantages that make them an attractive option for those looking to manage their security risk-return profiles. They allow you to get exposure to markets without paying huge up-front costs and taking on additional risks. You can also enjoy added returns, without accepting too much risk.
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