Introduction
Are you planning to visit a financial advisor on how you can get your investment options streamlined? If yes, then you may be put up with an overwhelming number of options out there.
You may have fixed deposits or fixed-income securities to choose from. Or, you can have a go at equity. You can buy and sell shares during trading hours at stock exchanges. Or, you can choose the hybrid investment option that gets you the best of both worlds.
This hybrid commodity is also known as a ‘structured note’. The investment banker curates a note that has a debt component and is often linked to the performance of an underlying asset.
Investors here get an option to customize their asset allocation baskets. You can choose between equities, stocks, shares, commodities, futures, options and high-net-worth currencies. Therefore, the options, investors have, to get their investment options streamlined, are limitless.
Broader Categories these Structured Products are Divided into
Structured notes are divided into two main categories:
- Structured products without capital protection and
- Structured products with principal protection
Let us look into the overview of each of the above:
1. Structured products without capital protection
Structured products without capital protection refer to notes that do not offer investors complete protection on their principal amount. As the notes are linked to equity assets, the performance of underlying assets plays a vital role in determining the value of investment at the end of its term.
- If linked assets like stocks, commodities, or indices rise in the equity market, investors get higher rates of return on their investment portfolios.
On the contrary, if these assets fail to perform well in the stock or equity market, then investors may lose a portion of their capital investment amount.
2. Structured products with principal protection
As the name suggests, structured products with principal protection refer to notes wherein the investor gets complete coverage on the principal money that gets paid out during the term of the investment plan.
In other words, investors get the complete value of their principal money towards the maturity period of the plan.
This is despite whether the underlying assets linked to these notes perform well or poorly in the equity market.
Structured Products without Capital Protection- Types Explained
Here is a list of products that come to you without capital protection. Helping you get started with the same:
1. Auto callable notes
Auto-callable notes are notes wherein the issuer adds a call option to the products. The notes are similar to promissory bonds that are linked to the underlying assets like equity, stocks, or currencies.
The initial values or strike prices of underlying assets in auto-callable notes are compared against the current prices of the assets during specific observation dates. Once the final units or sale units of underlying assets reach par or exceed barrier limits as set, the notes are immediately auto-called by the product issuers.
The notes therefore stand redeemed and investors receive the complete portion of their capital sum while interest earnings on auto-callables are paid out to investors in the form of coupon payments.
If the underlying assets do not meet specific prices as their initial set prices at the time of maturity, the investors may lose a partial or complete value of their initial investment. Auto-callable notes are sometimes referred to as callable notes.
2. Growth notes
As the name suggests, growth notes are also examples of structured products wherein the exponential return of capital solely depends on the performance of assets these notes are linked.
These notes allow the investor to benefit from appreciated values of stocks or ETFs (Exchange-traded-funds). Although the investors may suffer downside losses if the assets fail to perform, growth notes do offer investors partial protection of their capital sum.
The differences that arise between the potential hike of investments and the downside of assets may be a loss of capital to investors.
Therefore, growth notes may not offer investors with a 100% principal protection.
3. Equity-linked notes
Equity-linked Notes are also known as ELNs. These are notes whose returns solely depend upon the performance of the underlying assets the notes are linked to.
If the underlying value of equity assets increases due to favorable market conditions, investors get higher payoffs on their capital investment. On the contrary, if the assets fail to take off, then the investment portfolio may not provide attractive returns on investments. Notes can also receive dividends on performing assets.
Therefore, equity-linked notes or ELNs are typical examples of product offers without capital protection.
4. Absolute notes
Absolute notes evaluate if the structured notes meet the capped limits of equity participation, to which these notes are exposed. More often than not, investors potentially gain from equities from bear or bull markets.
While the stocks or securities fall under volatile market conditions, then the investor may not receive their expected returns on investment.
In other words, the negative performance of underlying assets directly hit the value of absolute notes in terms of return on investment.
Although note holders are exposed to the downside risks of equity, they do not lose a complete portion of their principal amount. The assets will be valued as of the date of maturity concerning absolute notes and the payment disbursals are done to investors.
5. Index-linked notes
Index-linked notes are structured products wherein the notes are linked to specific commodities or market indexes. by the issuer. A typical example of an index-linked note is the S&P 500.
If the pricing of specific commodities or indexes shows a hiking trend, investors receive their investment sum. On the contrary, if the indexed commodities fare poorly in the secondary market, then the investor loses a sizeable portion of his/her investment.
6. Reverse convertible notes or RCNs
Reverse Convertible Notes or RCNs are structured notes that are linked to specific underlying assets. The asset allocation comprises independent stocks, a basket of securities, or currency values, to name a few.
The performance of underlying assets determines whether you receive your settlement money as a wireless settlement or as cash-based holdings. If the assets perform well and meet pre-set conditions of RCNs then you get the entire principal amount and returns as a cash settlement.
On the contrary, if the assets fail to reach their initial prices, then the value of the assets gets converted into the stock value of the investor’s capital amount.
In other words, the investor gets shares of the underlying assets and this value may not be the exact proportion of the investor’s capital amount. It might be a little less than what was invested initially. That primarily explains why this is an asset portfolio without 100% capital protection.
7. Credit linked notes or CLNs
In the case of Credit-linked notes or CLNs, the notes are debt securities that are linked to the credit rating of a specific entity or sometimes a cluster group of companies.
The investors get a complete value of the principal amount or capital investment only if the performance of the entities shows a solid credit standing throughout the term of the investment.
On the contrary, when the companies or entities the notes are linked to default or survive at risk, then the investors may lose a complete portion of their principal or capital money.
Therefore, CLNs are examples of structured products that come without principal protection.
These are the top considerations investors must have a look at before they may want to invest in structured products. Here goes a run-down into the same:
1. Getting a know-how into how structured products work
Structured products comprise notes that combine debt with equity. Therefore, these are products that are a little complex to learn or understand unlike fixed-income securities, bonds, or even mutual funds.
Therefore, investors must do thorough research into how different types of structured notes work vis-a-vis and analyze their downsides or risk factors too. It is highly not advisable to invest in structured notes without getting a knowhow into how these investment portfolios work.
2. Analyze the credit rating of product-issuing firms
Analyzing the credit rating of product issuers is another important consideration for investors to invest in structured notes that are curated by these firms.
On a general note, these notes are issued by investment-grade banks, stock-holding firms, and secondary market-affiliated dealers or stock exchange firms. Therefore, the investor may have to get a credit rating of the product issuers before wanting to invest in the firms.
A poor credit standing of the product-issuing firm may be a major cause for investors to completely lose their capital investment or principal amount.
Take the case of Lehman Brothers. While the firm signed up for its insolvency due to the adverse liquidity position the investment firm was in, most of the structured notes issued by the said firm were rendered valueless.
Therefore, it is in the interest of the investors that they check the conditional credit rating of the firm before signing up for structured notes with them.
3. Approach an independent wealth manager or investment banker to discuss
As an investor, it is always the best idea to consult or approach an independent wealth manager or an investment banker to discuss the pros and cons of investing in every type of investment portfolio.
A personalized approach to investing is needed as every independent investor has a certain degree of risk tolerance he can take up under his belt.
Discussing each investment plan can help the investment banker or a wealth manager to curate a plan that can be tailor-made to suit the independent requirements of every investor. The risk profiling and KYC assessment are done here so that the right type of investing plan can be customized for investors as such.
Key Takeaways
Investors have various options by which they can customize their investment portfolios. That is why you call them ‘Structured Products’. The rate of returns and maturity dates also differ from one product to another ranging from 3 months up to 20 years.
You can link notes to assets, commodities, market indices, credit notes, mortgage notes, and hot-earning currencies, to name a few. Therefore, investors can diversify their investments by a limitless potential indeed.
However, structured products offer upside gains from underlying assets the notes are linked to and these gains are done post the volatility of market conditions. Therefore, the capital at-risk products can also be higher on the cards.
The breach of conditional clauses need not mean investors lose out on the entire portion of their capital investment. The investors must understand the different features of structured products to decide if notes provide enhanced returns over capital protection as well.
