A few weeks ago I wrote an article called Tips on Investing. Since then, in light of what has happened to investments with Continental Wealth Management, I have been asked to explain as simply as possible what structured notes are and why some are so risky. So here goes.

What are Structured Notes?

Put as simply as possible, a structured note is an investment whose 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 notes advertise an investment return with little or no capital risk. Other notes offer a high return in range-bound markets with limited or without capital protection. As you no doubt know, there is no such thing as a free lunch.

Generally, most structured notes are not capital-guaranteed. The investor may lose all or a substantial amount of his original investment in certain situations, which are described in the 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?

Here are just a few:

Credit Risk

Since structured notes are an IOU from the issuer, you bear the risk that the investment bank forfeits on the debt. Therefore, it is possible for the stock market to be down only 50% but the note to be worthless. Lack of Liquidity

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

Daily Pricing

The pricing accuracy is questionable.

Conclusion

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 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 this product if it is offered to them. If you have a structured note, call us to see if the product is in fact suitable to your needs and risk appetite.

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