In this insightful article, our Chief Investment Officer, Shaun Krom CIO at EasyEquities, talks about the world of structured notes. Structured notes offer a unique type of hybrid investment product that could be an attractive option for investors seeking a combination of capital protection, upside participation, and/or enhanced income generation.
Power of Capital Protection
A key characteristic of structured notes is their ability to provide capital protection, a valuable feature for risk-averse investors. Capital protection ensures that investors will receive their principal investment back at maturity, even if the underlying asset or index experiences negative performance.
This protection is typically achieved using embedded bonds and options strategies. These options contracts protect investors from downside risk by limiting their potential losses to a predetermined level.
Unlocking Upside Potential
While some level of capital protection is often a defining feature, structured notes also offer leveraged upside to the market, where the market could include international equity indices, commodities, and currencies. Leverage provides for an enhanced return; an example of leverage is a note that pays 120% of the return of the S&P 500. This means that investors can benefit from positive returns in the underlying asset, while still enjoying capital protection.
The specific way in which investors participate in the upside varies depending on the structure of the structured note. One common approach is to use options strategies that enable investors to capture a portion of the upside gains, while limiting their downside risk to the predetermined capital protection level.
Incorporating Enhanced Income Generation
Structured notes can also serve as an income-generating instrument, providing investors with a steady stream of coupon payments. These coupon payments are typically fixed or linked to the performance of the underlying asset, offering investors predictability and the potential for enhanced income.
Diversification
So, we have seen how a structured note allows for capital protection while providing a leveraged return and/or enhanced income yield to an investor.
Investing in structured notes can potentially play a valuable role in diversifying a retail investor's portfolio, offering exposure to specific market segments while mitigating overall risk. They can also help to achieve an investor’s risk/return goals.
Diversification can be achieved as an investor in a structured note can gain exposure to underlying assets that they might not otherwise be able to invest in, for example in currency or commodity markets. Investors can potentially reduce their dependence on traditional asset classes and potentially enhance their overall portfolio returns.
Another example is an investor who has a balanced risk profile that would keep a portion of their portfolio in cash or fixed income securities to reduce the volatility of their portfolio or provide them some income. A structured note could serve a similar purpose albeit at a potentially higher return. So instead of achieving fixed income return and structured note could guarantee capital while providing a leveraged exposure to the equity markets. Alternatively, a structured note focusing on income generation could potentially offer a higher income stream than traditional money market or fixed income investments.
In conclusion, retail investors often predominantly hold equity investments and are thus exposed to market volatility and potential capital loss. Structured notes can be effectively incorporated into an equity-only portfolio to address these concerns and enhance the overall risk-return profile.
A Strategic Tool, Not a Stand-Alone Investment
While structured notes offer unique benefits, it is important to remember that they are not a stand-alone investment. Retail investors should carefully consider their risk tolerance, investment objectives, and time horizon before investing in structured notes (or any other investment).
We recently added the BNP Paribas ZAR Capital Protected Note Structured Product on the platform. To know more on why this could be worth considering for your investment portfolio, click here.
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