Understanding structured notes

What is a structured note?

Put as simply as possible, structured notes are a type of investment where the return is linked to the performance of one or more reference assets or benchmarks. These assets or benchmarks can include market indices, equities, interest rates, fixed-income products, foreign exchange rates or any combination of these.

Some types of structured notes advertise an investment return with little or no capital risk, while other structured notes offer a high return from range-bound markets with limited to no capital protection. As you no doubt know, there is no such thing as a free lunch.

Generally, most types of structured notes are not capital-guaranteed. The investor may lose all or a substantial amount of their original investment in certain situations. These are described in the structured note term sheet. The higher the return, the higher the risk – you could lose all of your investment.

What Are the Disadvantages of Structured Notes?

While structured note investments, of course, come with potentially impressive returns, it’s important to understand the risks as well. Here are  a few of the disadvantages of structured notes:

Credit Risk

Since all types of structured notes are an IOU from the issuer, you bear the risk that the investment bank forfeits on the debt. Therefore, while possible for the stock market may ‘only’ be down 50%, your structured note to be worthless.

Lack of Liquidity

When investing in any type of structured note, your money is tied up for a set period of time, usually 4, 5 or 6 years. There is a secondary market that works well most of the time, but it should be made clear that some structured notes may be extremely illiquid.

Daily Pricing

Before investing in structured notes, you should be aware that the pricing accuracy is notoriously questionable.

Structured notes are very complex and few really understand how they will perform relative to simply investing in funds or directly in the markets. I feel the disadvantages of structured notes such as credit risk and illiquidity must be given proper consideration.

In the main, structured notes investments are considered only suitable for experienced/professional investors who have the ability to absorb a loss of capital in return for higher potential returns. At Blacktower we do not consider these products as a solution for our ‘retail’ clients.

For these reasons, the majority of investors, with the exception of experienced investors, should just say NO to all types of structured notes. If you have a structured note, call us to see if the product is in fact well-suited to your needs and risk appetite.

Disclaimer: The above information was correct at the time of preparation and does not constitute investment advice. You should seek advice from a professional regulated adviser before embarking on any financial planning activity.