Introduction
Do you want to know more about the types of investments or securities that expose you to the equity market yet help you receive your principal amount at the time of redemption?
As a conservative investor, you cannot afford to lose capital money, isn’t it? And, fixed deposits seem to be the only option here. If you feel so, then you are not the only one. You have several structured investing options that provide you with capital protection and at the same time help you achieve reasonable returns on your investment portfolio.
Let us get you started on structured products with principal protection.
Structured products with principal protection are hybrid investment options with debt elements, linked to equity. These are notes that provide the investor with a 100% return of capital money irrespective of the performance of underlying assets, the notes are linked to. However, the index or benchmark differs from product to product.
In other words, irrespective of whether underlying assets perform well, you are assured of your capital money by the maturity of the term. The risks associated with structured products also go into account while you choose your products.
7 Different Types Of Structured Products With Principal Protection
Helping you understand 7 different types of structured products that offer investors zero credit risk and 100% protection of the initial investment amount. The list follows:
Principal Protection Notes
Principal Protection Notes are otherwise also known as PPNs. The note may be linked to equities or derivatives. These are notes that provide capital protection and investors receive a complete value of their investment as the notes mature.
However, as PPNs are linked to the underlying assets, the investment portfolio’s upside potential is linked to the performance of underlying assets at the time of maturity.
Structured CDs
Also known as Certificates of Deposits, structured CDs are favored by traditional investors who may never want to part away from their capital investment. The CDs are linked to FDIC (Federal Deposit Insurance Corporation) insurance products.
FDIC guarantor CDs are held until maturity to receive their principal money. Although investors are guaranteed a return on principal that they had remitted during the initial level, their interest earnings are not fixed.
As these notes are linked to insurance products, the performance of underlying assets determines the rate of returns on CDs.
However, these are structured notes with principal protection that allows downside protection to investors. In a nutshell, you must note the terms associated with structured CDs.
Reverse Convertibles
These are bonds exposed to the equity market wherein the performance of underlying shares or options has a bearing on the returns on investment.
If the underlying assets perform well, then these notes provide complete protection to the investor’s initial capital wherein the principal money and yields the portfolio gathers stands credited to the investor’s bank account.
However, if the underlying shares or options (call/put options) fare badly or poorly in extensive markets, investors get shares of the underlying assets instead of the principal money. In other words, they could lose a cash component of the investment commodity.
Once the shares hike up in equity, you can sell them for a profit that helps you get back your principal amount and the returns. You must go through the terms of your investment before you consider structured notes of this genre.
Market Linked GICs
GICs are also referred to as Guaranteed Investment Certificates. As the name suggests, GICs refer to investment options that surely repay investors with their initial capital money. And these are notes that provide fixed-income returns against the investor’s capital.
These certificates are issued by bankers after performing thorough KYC checks on investors. A mandate risk profiling is done on every investor before the GICs are issued.
The GICs offer varying participation rates to ascertain capped values of returns. However, you must hold these notes to avail capital protection at maturity.
Structured ETFs
ETFs stand for Exchange Traded Funds. This is an investment portfolio that comprises of pooled reservoir of underlying assets instead of one.
In a structured ETF, the note is designed in a streamlined manner to protect the investor’s capital against growing index rates in the stock market.
You can expect higher rates of returns if the underlying shares or stocks perform well in the primary or secondary markets.
To provide investors with a complete return of principal coupled with returns, the ETFs employ various tools to achieve their objectives.
The derivatives go through call or put options and are subject to swaps to provide enhanced returns on capital investment. The creditworthiness of the issuer also plays a vital role in how investors can achieve their capital payoff with returns added to it.
Buffered ETFs
In these ETFs, the buffer losses are safeguarded up to specified percentages. Investors mostly get their principal money if the notes are held until the maturity period.
However, if the performance of the underlying assets declines, the investors may not get enhanced returns on their investments. In other words, the upside potential of buffered ETFs is capped.
Investors must go through market terms and conditions carefully before investing in buffered ETFs to discover investment risks about the same.
Equity-Linked Notes With Capital Protection
These are structured notes that are linked to individual stocks or shares belonging to the equity market. The Equity-linked notes with capital protection have an inbuilt mechanism to repay the return of capital or the initial principal investment to investors.
However, as the notes are linked to equities, the performance of the underlying assets comprising stocks or shares determine the returns on the investment, the investors are most likely to receive.
As the underlying assets perform fairly well in the equity market, investors earn potentially higher income in the form of interest or dividend earnings. This is apart from earning their principal-protected funds.
Why Do Investors Prefer Investment Products That Are Fully Capital-Protected?
Most of the investors have their lifetime savings deposited in investment products like bonds, fixed-income securities, or even structured products. Hence, they may rather pay an extra premium to safeguard their capital investment than get higher returns at the risk of losing their principal money.
Most traditional investors prefer investing their money into CDs or structured deposits even if the financial firms offering these products give away a modest rate of return on the money invested.
Above all, when the investment product says ‘Capital Protected’ or ‘Principal Protected’, investors get a sense of security and confidence to invest their hard-earned currency. The guaranteed return of their capital boosts their assurance of investing in these products.
Hence, these are the primary reasons investors prefer investing their funds via capital-protected investment products over other volatile instruments.
What Happens In An Equity-Market Scenario?
The volatility of bearish or bullish markets may cause stocks or shares to rise and fall and most investors are wary about investing in the stock markets as they are afraid that they may lose it all. In a nutshell, you will receive potentially higher returns if the equities perform well or you could lose your entire capital.
Take the case of Lehman Brothers. When the leading investment banker signed up for insolvency, most of their shares were rendered valueless. Therefore, the safety of your overall investment is also subject to the creditworthiness of the financial firm, as the issuer goes bankrupt, you may lose your investments typically.
Changes in market index values and equity indices, imputed interest rates, and other factors impacting the equity market can have a detrimental impact on receiving your initial investment at maturity.
These are the primary reasons why investors are wary about investing in the equity market.
Key Takeaways
As you have already seen, some of the principal-protected notes may suffer a lack of liquidity as they fail their promise to repay the principal amount invested. Investors may not get their full principal if the notes are not held until maturity dates. This is because the structured note may be linked to an underlying asset.
All investment opportunities come with their own set of complexities, risks, and reward options too. Some structured products also offer partial protection of the principal amount and are not completely risk-free.
The downside risks the investors are exposed to are something inevitable. You may also encounter a situation wherein the financial firm goes bankrupt. In this case, the note goes bankrupt as well. In other words, the investor may not get his principal back.
You must have risk tolerance and understand the tax implications of the portfolio.
Experienced investors who have a higher degree of risk tolerance take downside losses and upside gains in a balanced manner and hence see more profitability on their investment moves. And, they eventually see their wealth baskets grow!
