The War in Ukraine, Inflation, Bear Markets...the negative headlines are dominating the news and the financial markets have reacted accordingly with some of the steepest declines we've seen in years. What can an investor to do to generate an attractive return?
One possible solution for an investor who would like to generate an attractive return is a market-linked structured note.
What is a Structured Note?
A structured note (product) is a type of debt security, issued by any one of the large investment banks, where the return is linked to the performance of another asset, such as a stock or market index. While the majority of a structured note consists of a zero-coupon bond, the remainder is an options package which determines the payout/participation and protection levels. Each structured note has a finite maturity date (however some may be called prior to maturity) and is subject to the credit of the issuer.
Here is video describing these notes in more detail.
Why Invest in a"Market Linked Income Note"
An investor who wants to generate a higher income stream than traditional fixed income securities or funds may want to consider these types of structured notes. An investor who is looking for average, annualized equity-like returns with limited protection from equity market declines may also want to consider these investments. Below are two examples of contingent income notes that we recently priced for our clients.
A very attractive option for very conservative investors:
For investors who were looking for a very attractive (8.3%) income stream with 100% principal protection up to a catastrophic 50% market decline. 2
This note issued by JP Morgan Chase will pay a 8.3% annualized yield on a monthly basis unless the Russell 2000 Value ETF, Russell 2000 or S&P500 stock index are down more than 50% on the monthly observation date.
Monthly coupons will not be paid if one of these referenced stock indices continue to be down more than 50%. Principal will be at risk if one of the referenced stock indices is down more than 50% at the 21 month maturity date (from inception date). Historical market declines of more than 50% are extremely rare as shown in the index links above.
Basically, for investors to lose principal, these stock indices would have to return to levels not seen since November 2012 (Russell 2000 Value), April 2013 (Russell 2000) and May 2016 (S&P500) by maturity on February 1st, 2024.
An attractive option for investors looking for attractive income with downside protection:
For investors who were looking for a very attractive (14.4%) income stream with 100% principal protection up to an extreme 30% market decline. 2
This note issued by JP Morgan Chase will pay a 14.4% annualized yield on a monthly basis unless the S&P500 (SPX), Russell 2000 Value or Russell 2000 (RTY) stock index are down more than 30% on the monthly observation date.
Monthly coupons will not be paid if one of these referenced stock indices continue to be down more than 30%. Principal will be at risk if one of the referenced stock indices is down more than 30% at the 21 month maturity date.
What are the risks of a market linked income note?
When the issuer of the note defaults, the entire value of the investment principal is at risk of not being repaid. This is the same risk associated with investing in an other corporate bond. Investing with high quality banks with strong balance sheets reduces this risk. The vast majority of notes are issued by investment grade banks.
The maximum benefit of investing in a structured note is usually realized by holding until the maturity date. There is a secondary market but it's is limited to broker dealers and their affiliates and distributors. This means that any sales made prior to maturity could be at a discount to the current market value.
Losses are only protected according to the terms of the individual note. Principal is at risk if one of the referenced stock indices is down more than the barrier level at maturity. In the two examples above, these levels are 30% and 50%, respectively.
Keep in mind in the event of these extreme market loss scenarios alternative income producing options are also likely to decline significantly in value. and an investor keeps any coupon payments earned to date.
#4: Call Risk
Income notes usually have a call feature which means the bank can redeem the note before the maturity date. This means that investors will receive a return of their invested principal while keeping any interest payments paid to date. In the two examples above, these notes can be called back to the issuer after 3 months.
Please click on the offering hyper links above to see all risks and disclosures related to these specific note examples.
Why invest with a Registered Investment Advisor & Claro Advisors
While the traditional big banks offer a continuous "calendar" of offerings, it is almost always to the investor's advantage to work with an independent advisor that is experienced in working with structured notes. As a Registered Investment Advisor, we have access to a larger selection of multiple bank offerings and don't charge the fees and commissions that erode the income and protection terms of these products.
Furthermore, since structured notes are a specialty of our firm, we are proactive in leveraging our relationships to customize notes on a timely basis with superior pricing terms for our clients. In the case of the two examples above, these notes were deliberately created during short windows of volatility to maximize benefits and minimize risk to the investor. These notes were not available to clients of the traditional banking firms.
- Source: Bloomberg, data from 12/31/86 through 9/30/20.
- Performance figures do not reflect the deduction of investment advisory fee. Client’s return will be reduced by the advisory fees and any other expenses it may incur in the management of its investment advisory account; Investment advisory fees are described in the Advisor’s Form ADV Disclosure Brochure.
- This content is developed from sources believed to be providing accurate information. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.