What are
Structured Notes?
Structured Notes (Products) are debt securities issued by banks and are ultimately designed to protect investor’s principal, enhance returns or provide income.
They are designed to provide a return based on the performance of an underlying asset. Most often this asset is either a stock index, exchange traded fund (ETF), or single stock. For this reason they are sometimes referred to as “market linked bonds.”
The advantage of these investments is that an investor can pre-define both the payoff (how the investment pays) and the level of capital at risk (how much you can lose). In doing so, investors create a level of certainty over the life of the investment. Payoff profiles can be designed to take advantage of rising, falling or range-bound markets, and delivered in a way that can be tailored to the needs of investors.
These notes are designed for investors who are prepared to invest for a fixed period, and who also want a level of downside investment protection against market declines, while still allowing participation in potential market appreciation.
Common structured note strategies typically fit within one of the following categories:
Equity exposure with enhanced upside and downside protection
Fixed income alternatives with enhanced yields
Smart cash replacements with FDIC insurance
For more information, check out this Educational Video
History of Structured Notes
Structured notes have been available for many years worldwide. They have been very popular with retail investors in Europe starting in the 1980s with the greatest adoption rates in Switzerland, Germany and the United Kingdom. They continued to gain in popularity while expanding into the Asia market during the 1990s.
It wasn’t until the mid 1990’s that structured notes started become more popular with US investors. But high investor minimums (as high as $1 million) made them accessible to only the ultra-wealthy and institutional investors. Meanwhile, both financial advisors and investors lacked the knowledge and resources that would help these practical investments go mainstream.
Current Landscape
Over the last several years, there has been an uptrend in the usage of structured notes by financial advisors and individual investors. This increase in popularity has largely resulted from increased investor access, greater transparency, better liquidity, lower fees and improved education.
Financial Advisors have gained increased access to these investments through fintech platforms that have streamlined the distribution, transparency and purchase of these investments. Meanwhile, record low interest rates have spurred the need for alternative sources of investment income as traditional fixed income loses its appeal. The ability to gain protection from stock market declines while being able to participate in gains has also drawn in a lot of investors.
Today, the structured note market is over $3 Trillion with a record $91 Billion in notes issued in 2021 – which was over 26% increase from all of 2020. It’s still early, but 2022 is expected to be another record year.
Common Misperceptions of Structured Notes
There is a lot of information on structured notes that can be both overwhelming and/or misleading. Below is a an article from one of our service providers that does a good job addressing some of these misperceptions.
Risks of Structured Notes
As with any investment, structured notes do have risks which means they are not suitable for all investors.
These risks include, but are not limited to the following:
Call Risk
Some structured notes are callable or redeemable at the option of the issuer. If called, an investor may be unable to reinvest the proceeds with similar or better terms to the original investment.
Creditworthiness of the Issuer
Structured notes are unsecured obligation of the issuer and therefore are subject to the risk of default. The issuer’s creditworthiness is an important consideration when evaluating any structured notes.
Fees
Structured notes are subject to fees and costs, which may include amounts payable to a financial professional, structured and development costs, and offering expenses.
Dividend Risk
Structured Notes do not participate in dividends. Structured notes are linked in the price return of the underlying asset and derive their market exposure from options, which don’t produce dividends.
Liquidity Risk
Typically, the issuer will maintain a secondary market; however, there is no obligation to do so. There may be little to no secondary market available.
Potential Loss of Principal
Investors will not participate in any price appreciation of the underlying asset nor will they receive dividend payments generated by the underlier. Notes are not principally protected, and investors can lose some or all their initial investment.
Market Risk
Volatility and other market forces, such as interest rate fluctuations and inflation, can affect the value of the underlying asset, which can affect return. Historical performance of the underlying asset is no guarantee of future performance.
Structured Notes are sold only by prospectus and investors should read the prospectus and pricing supplement carefully before investing as they contain a detailed explanation of the risks, tax treatment, and other relevant information about the investment. The tax treatment of structured notes varies depending on the offering, and can be uncertain in some cases. Structured products are sold through financial professionals and investors should consult accounting, legal, and/or tax professional before investing.
Want to learn more about risks? Check out this educational video or view our structured notes disclosure here.
How do they work?
A structured note is basically a zero coupon bond tied to a derivatives package. These derivatives are usually in the form of call and put options that can hedge against market volatility.
The majority of a the investors principal is invested in a the zero coupon bond issued by the bank. When the bond matures, principal plus interest is returned to the investor. Meanwhile, the remaining amount invested in the derivatives package provides the enhanced returns and protection.
Check out one of our service providers articles for a more detailed explanation:
Understanding Statement Values
It’s important to know how structured notes are valued on a client statement. Check out this article from one of our service providers discusses this topic: