What You Need to Know
- A structured note consists of a bond and one or more options.
- Structured notes can provide unique exposure that's not available through investments like mutual funds or ETFs.
- A default by the issuing bank would severely reduce the value of each note, as they are unsecured debts.
Structured products have the connotation of institutional or off-the-grid usage for most investment advisors. However, we’ve utilized structured notes as a complement to long-only mutual funds and exchange-traded funds in client portfolios for years.
During the financial crisis, we used them as a “repair and recovery” strategy in an attempt to recoup the losses that occurred in the fall of 2008. Currently, we use them as a hedge within our clients’ portfolios. Structured notes can be used to offer hedged or leveraged exposure depending on your viewpoint.
But let’s start with the basics:
What are structured notes?
These products are extremely flexible investment vehicles that can be used by investors and advisors in a variety of ways. They can be used as an income replacement vehicle, to hedge a portfolio or to provide unique exposure that is not available in traditional investments such as mutual funds or ETFs.
How long have structured notes been in existence?
We’ve been using structured notes since 2008, but they have been around much longer and have been widely used for decades in Europe and Asia where investors are more risk averse. One reason why they are more widely used in Europe is that business schools in Europe teach options-based strategies as part of their curriculum.
What variables are involved in a structured note?
Tenor (duration) of the note, downside protection (buffer or barrier), upside participation (leveraged or unleveraged), underlying product (stock, index, ETF or other investment) and size (notional amount) of the trade are variables involved in each note.
Advisors need to have a view of the stock market or individual security before requesting pricing of a note. Are you bullish or bearish? Typically, you need to have a viewpoint before selecting an appropriate structured note to utilize within a client’s portfolio.
How is a structured note created?
Structured notes contain essentially two components: a bond and a single or multiple option(s). The bond portion of the structured note serves as collateral for the trade. The option portion can be linked to a stock, index or ETF.
The simplest structured note available is a principal protected note that consists of a zero-coupon bond and an option tied to an index such as the S&P 500. If the stock market declines, you will receive your principal back but will need to pay some original issue discount (OID) on the zero-coupon bond. If the index rises, you will participate to some degree in the gains. Structured notes are created by investment firms and multinational banks.
How can I purchase a structured note?
Investors can purchase structured notes directly from their broker-dealer or custodian via monthly offerings, or through a platform, such as Halo Investing. In addition, custom notes can be created at values as low as $500,000.