Introduction
Are you aware of a new component reaching phenomenal growth in the investment industry? You may have heard of fixed deposits, equities, and commodities! For all said and done, we have also been hearing about booming businesses that buy and sell currencies.
Well, this is a new form of investment that has always intrigued investors. These are structured notes that we are talking about.
Structured notes comprise a two-structured pyramid of debt obligation linked to an asset or investment. The asset allocation can take the form of equities, shares, currencies, credit notes, and mortgage bonds and the options are limitless. In a nutshell, these are hybrid notes that comprise debt and assets clubbed into one.
Why structured notes might not be right for you?
Structured notes may offer features that regular bonds or fixed-income securities do not have. Let us have a detailed overview of what kind of lucrative benefits you get from investing in structured notes:
Pros of Structured Products
1. Highest degree of customization of investment products
Structured notes comprise debt and derivatives. These notes are difficult to determine as the embedded components comprise derivatives and underlying assets.
Here, an investment banker or wealth manager sits hand-in-hand to discuss his expertise with you. You then get to choose the promissory bond and the underlying assets you may want to include within your investment spectrum.
The underlying assets can be in the form of independent stocks, a basket of equities, credit notes, market indices, and currencies to name a few.
After a thorough risk profiling, the investment manager discusses the type of risk tolerance you can carry under your belt before you even start investing. You can then customize assets that can fetch you maximum returns in your portfolio.
Well, don’t you like having a tailor-made investment product that takes care of your wealth generation objectives seamlessly? If your answer is no, then structured products may not be right for you.
2. Wider exposure to the market
As you have already seen, structured notes are products that comprise an optimal mix of debt and derivative components. The promissory bond is issued in the name of the investor in the primary market. The bond component provides downside protection to your capital investment.
As the notes are linked to underlying assets like stocks, shares, and currencies, the upside potential toward gaining higher returns on capital investment primarily depends on the performance of these underliers that the notes are linked to.
And, the product issuers of notes provide embedded options like the inclusion of barriers and buffers that provide downside protection against investor’s capital
Therefore, investors get downside capital protection with returns linked to the equity market. This is an enhanced market exposure you get against bonds or fixed-income securities.
You can also opt for risk-free and principal-protected notes for maintaining your risk management or market risk volatility at the bare minimum. You can leverage high interest rates like hedge funds. This way, you have limitless opportunities to explore every type of market.
Doesn’t this benefit sound lucrative to you? If not, then structured notes may not be right for you.
3. Get hands-on with customized payout plans
As you all must be aware, structured notes are curated to cater to a wide range of investors. It can be high-end retail investors or the sophisticated form of institutional investors.
With so much of a technological boom happening in the financial world, these notes that were once available to a select group of investors are now foraying to serve the needs of middle-class retail segments too. The notes were issued primarily by investment banks and sophisticated institutional companies.
For instance, autocallable notes can be purchased from a secondary market for as low as $1000 per note. And, as the notes have embedded derivatives, you get enhanced yields as compared to your regular bonds or fixed-income securities.
That being said, as a structured product investor, you can also get hands-on with customized payout plans that suit your financial objectives and can achieve your short or mid-term goals.
You can choose income notes if you want downside protection against your capital investment with an enhanced source of income as and when the underlying derivatives are exposed to favorable market conditions. These are in the form of fixed-income coupons like how you may receive in regular bonds.
As investors, you can also choose structured notes with principal protection that yield optimal interest rates as payoff or earnings.
For those of you who want to seek an upside potential with increasing equity valuations or in other words, for those of you who want to see your assets grow, you can choose growth notes as a viable payout option. Growth notes provide fixed-income coupons and increased yields in the form of dividend earnings if the underlying assets perform well in the market. Hedge funds can also be created with notes.
In a crux, you find an amazing degree of flexibility in choosing your very own income-generation payouts that meet specific wealth objectives.
Don’t you want this form of a customized payout option? Well then, structured notes might not be for you.
4. Quicker rate of returns
Similar to receiving payment options on a customized level, you can also avail quicker rate of returns from structured products. For instance, you can choose autocallable notes wherein the assets are monitored during said observation days.
Once, pre-set barrier levels of asset pricing are achieved, the notes are auto-called by-product issuing companies. Therefore, investors get redemption of their principal money and get returns in the form of coupons. This happens even before the maturity of the product. In a nutshell, the issuance of notes therefore creates a comfortable buffer for investors who want to redeem without the hold-up time involved with regular investments.
Therefore, you can get structured notes that come to you on a short-term or medium-term level so that you get quicker returns as against waiting the entire term in the case of bonds, fixed-income securities/ETF schemes, five-year term loans, etc.
Don’t you want a quicker return on capital and earnings before the term of the investment? Well, if no is your answer, then structured products may not be right for you as such.
5. Better than direct investments in blue-chip stocks
As has already been said, most of the structured products have embedded options with soft buffers or hardcore protective layers that provide an ample degree of downside protection against investor capital.
For instance, if you purchase income notes with a 15% downside protection, then even if the performance of the underlying assets goes down by 10 to 15%, the investors can still claim a complete value of their principal amount as you have a barrier-level or downside protection to that extent.
Whereas when you invest in direct stocks of blue-chip companies, you may lose a lot more if the stocks you have bought from a stock exchange plummet badly in the stock market. Therefore, investing in structured notes is better than direct investments in blue-chip companies.
If you do not like this particular option in your investing realm, then structured notes might not be right for you.
6. Diversified investment portfolio
Investing in structured notes opens doors to a diversified investment cum income-earning portfolio. This is because these are hybrid components comprising an optimal mix of debt and equity.
On one hand, you have your capital protected through flexible embedded options that you can apply to the notes. While, on the other hand, you get exposure to receiving lucrative income payouts when the underlying assets of the notes are exposed to growing market conditions. You can also earn coupons, and regular income payouts in the form of dividend earnings and seek an upscale potential when the exposed asset fares well in the market.
Some of the investment notes like say your Reverse Convertibles allow you to convert your principal component into shares of the aforesaid underliers.
Therefore, investing in structured products is a way to diversify your income earning cum investment potential.
Well, if you do not endorse diversifying your income, then structured notes might not be right for you.
Cons of Structured Notes
These are some of the potential cons you have about structured products. Let us have a run-down into what these are:
1. Limited range of liquidity
Structured notes are relatively newly introduced forms of investments as against stocks, bonds, or mutual funds that are more widely traded in the market. Moreover, these notes are highly customized to suit the wealth generation objectives of independent investors. What may sound conducive to one may not suit the other. Therefore, these notes are expected to be held until maturity to seek redemption of principal money and yields these notes may provide. In a crux, the lack of liquidity for the note would be a potential concern indeed.
2. The rate of returns cannot be pre-determined
The net value of assets is determined using a multitude of techniques as adopted by the product issuers of these notes. The pricing of the assets is done by a matrix method more commonly known as an average guessing method.
That being said, you cannot determine how much returns you get at the end of the term. This is because the valuation of assets is done on specific observation days. When the assets remain volatile or trade-low margins of underliers dip sharply, then the investor loses the final payouts and even loses a part of his initial investment.
For instance, you have an income note that is tied to Proctor and Gamble or what can be abbreviated as P&G. If P&G performs better than its initial purchase points or scores above threshold barrier limits that have been set over 4 years and 11 months, then the investor may receive the entire portion of his capital investment and the coupons that accrue thereon.
On the other hand, if P&G plummets interim, then the coupons will not be paid to the investor and the initial investment will drop to the extent the portfolio is not buffered. In a nutshell, structured notes are complicated to learn or understand for first-time investors.
3. Credit risk
The credibility of the product issuing firm also plays a major role concerning the return of capital on structured products or notes. Only if the credit rating of an investment firm is robust only the investor get his principal and returns.
If the credit rating of the issuing company gets impacted adversely, then the investor could lose the entire portion of his capital investment.
Take the case of Lehman Brothers. In the year 2008, this investment firm signed up for its insolvency, and all of the structured notes issued by Lehman Brothers were rendered valueless.
Therefore, investors must gauge the creditworthiness of the issuing firm before investing in shares or notes of that firm. You must look at the prospectus before investing.
4. Tax implications
The tax implications may differ from one product to another. This is especially true for structured notes. You may never know if the income you earn from structured products is taxed as regular income or will be taxed lower if the income you receive from an investing plan is treated as capital gains. You may have to consult a tax advisor before you sign up for a structured product as the tax implications have a direct bearing on how much investment value will you get upon redemption. In a nutshell, each type of structured product may have different taxation norms
5. Higher amount of fees
Structured products charge heavier fees in the name of transaction or processing as compared to bonds, fixed-income securities, or mutual funds. And, this can have a bearing on your investment value.
Early redemption fees or coupon payment fees may also be levied on structured notes. You may have to get a thorough overview of how the fee structure works as it can differ from one product to another.
The US Securities and Exchange Commission determines pricing slabs on different investment products.
The Bottom Line
Every investment plan has its own set of pros and cons. As an investor, you must carefully weigh the benefits and drawbacks of different investing options before you can zero in on the right one.
Investment plans also come to you through a fleet of credit, market, and liquidity risks to name a few. One must learn the risks before investing.
Reading the offer documents carefully is a must-do before you choose any investment plan.
