Structured Notes and Products – Returns and Risks

  • 25 December 2019 | 1066 Views | By Mint2Save
Structured Notes and Products - Returns and Risks

Investments in stocks have garnered a lot of interest and the investor’s range has diversified from huge funded companies to small-time regular companies and interested buyers. Innovation in financial sectors and expansion of the investor class changed the way the equity and debt instruments have been defined by the asset managers. This change in the investment class which acts as a supplement to the traditional institutional and retail portfolios is called Structured Products. Let us see and figure out the way these structured products work and the risks and return associated with your next investment venture.

Key points of Structured Notes

  • Increasing popularity and $2 trillion assets gaining momentum in the global market.
  • Earlier available to institutional investors or high net worth individuals, but now easy accessibility to many in the market.
  • Structure notes are a combination of an 80% bond component and 20% derivatives.
  • The pre-packaged investments, Structures products include interest-based assets and one or more derivatives.
  • Replacement of regular payments with nontraditional payoffs is observed.
  • Structured products offer principal guaranteed returns on the maturity date.
  • Risks involved with structured products are complex.
  • These hybrid securities are the liability of the issuer.

Introduction to Structured Notes and Products

Structured products are hybrid products issued by major financial companies that compromise 80% bond and 20% derivative. 

Constitution of a Typical Structured Note

Structured Note is the debt product whose performance value is based on one or more of the underlying assets. The principal repayment and the interest payable on the structured note is dependent on the operational achievement of the assets. A structured note is a pretty complex product whose working is dependent on many factors and the major factors influencing the executive are credit risk and collateral value.

  • The credit risk of the issuer and the counterparts of the issuer credit risk is the major factor that contributes to the performance of the structures notes
  • Any change in the provided collateral also affects the returns on the structures notes
  • Asset performance decides the profit or loss and as the return on the principal amount. If the benchmark underperforms, one can see a loss as well as it’s the effect on the principal amount too.

There is an investment lock period on the structured products and the associated lock time typically ranges from 3 to 10 years. 

The reference assets or the referenced benchmarks are known as the underlying assets or benchmarks. These assets or benchmarks that comprise the returns achieved by the structured notes are 

  • Equities
  • Interest rates
  • Market indices
  • Foreign exchange rates
  • Prices of commodities;
  • And a combination of any of the above

The invested amount in the structured noted is ties up for a long time and they aren’t even principal guaranteed. Return on investment before the maturity date is not possible or if such an option is there, it is typically associated with more money involvement.

Types of Structured Notes

The availability of the structures notes depends on the return rates associated with them. Various types of structured notes are:

  • Equity-linked Structured Notes: In the equity-linked structures notes, the returns are shares or a combination of various companies’ shares.  At the time of principal repayment, the investor may receive shares instead of the cash invested. The shares or indices are allowed to the investors equivalent to the amount they have invested. The return value here is a single or a basket of shares or indices.
  • Interest rate linked Structured Notes: In this type of structure notes, the return value is linked to the interest rate of the underlying assets. The change in the value of the interest rate may increase or decrease the return value. If the loan interest rate is decreased then a profit in the return value is observed. The direct effect of the interest rate is observed in such a dependency of structured notes.
  • Credit linked Structured Notes: The occurrence of a credit event decides the future of the investors and the amounts invested. The solvent of investments, or default on the loans or the associated credit risk of any of the collateral implies the risk and return of the structured notes. Credit risk of the company and the counterparts also becomes a part of establishing the risk value and any issues with any of them affect the accomplishment of the return values of the structured notes.
  • Currency linked Structured Notes: The currency values of USD, Euro decides the returns of the invested structured notes. This reference currency values increase or decrease determined the profit or loss of the amount invested in the structured notes.
  • Commodity-linked Structured Notes: A combination of various commodities rates to stocks and induce a decides the returns associated with the structured notes that are linked to commodities. The performance of the basket of these indices determines the return value.

Are Structured Notes a suitable option?

There are various reasons why a person invests in regular methods like trading securities, deposits, lands or even gold. Based on the returns, duration, and necessity of the investment, a specific method of investment for the amount is chosen. Let us delve into the reasons and other things that can make the decision to invest in structured products easy.

  • Go for it when one substantial returns are the one you are looking for and at the same time risking losing a part or whole of the amount invested.
  • Have a better understanding of the various underlying assets and the dependencies taken into account that decides the calculation of the returns.
  • Knowing all the risk factors and the of the issuer and the counterparts gives a clear picture of the derivatives and it’s involvement.
  • Be sure and aware of the lock period of the invest and wisely take a decision of the investment. If no need for a short term investment, then you can choose this structured note.
  • Be prepared to lose a part of the number of stocks in case of the early reception of the investment. It’s always good to know the terms and conditions of the issuer’s options for the early withdrawal of the investment.

One has to understand and weigh the need before doing for the investment option based on the benefits and the associated risks also.

Benefits of investing in Structured Notes:

This is the perfect type of investment when one doesn’t want to lose the whole of the capital. Structured notes and products medium level of risk for the investment made without losing all of the principal amounts invested.

The protection level can be fixed and the return proportion of the investment is ensured safe.

With the technological advancement observed in the market globally, the accessibility and the trading of structured noted have proven to be a more beneficial and rewarding experience.

Structured Notes and the risks involved:

The risk of any investment is the loss of the amount or the interest invested. Maturity, pay off, underlying asset and protection are the parameters that decide the risk and returns of the structured note and products.

The great risk of losing a major portion of the investment is seen along with higher returns too. Any underperformance of the assets or the associated assets and benchmarks results in the loss of the amount invested. If the return options are shares or indices and the lowered value of those furthermore depletes the invested value.

  • Risk is that the value of underlying assets doesn’t move in the direction anticipated by the investor.
  • The average of the counterparts of the investment may affect the total return value
  • The overall risk of the product is based on a large number of reference assets
  • Is shares are return option then the risk involved is that you may have to own them at a higher price than the market share price
  • Interest rate variation risks the direction of the return rate of investments made
  • Not having an understanding of the happening of credit events may reflect in the likelihood of looking a part or whole of the investment

Returns observed in the Structured Notes:

Interest or returns is provided by the issuer of the structured noted to the investors in this type of debt obligation. A number of factors and the type of structured note issued by the company decided the type and amount of the interest provided to the investors during the entire lock period of the structured notes.

The interest paid is a direct fixed value or a calculation of the values of the underlying benchmarks or assets through usage if a formula. 

The Capital gains or returns on structured notes are dependent on the underlying assets and benchmarks exposing them to a greater risk but at the same time higher interest rates. Potential returns are observed compared to traditional investment methods. This higher interest rate and capital appreciation are making these structures notes gaining huge popularity globally in the trading market. 

Diversifying the investments is best suited for everyone to achieve better returns and the products of the structure are one of the best available tools to achieve that. Having a balanced range of investment solutions is perfect to construct and effective financial strategy.

Investing in the structured notes assets class properly will improve the return potential at a minimum risk. These instruments haven’t been much popular with the common man, owing to the high investment threshold. However, the global AUM of these products is at par with some popular investment vehicles such as mutual funds, commodities, real estate, etc. 

There have been attempts to make the market more accessible to investors, which has been done by:

  1. Lowering the investment threshold, and;
  2. Maximising the technological horizon for education, investment analysis, enhancing competition and easing the liquidity of the products.

As we delve more in making the global market local, structured notes can be the next big thing for retail as well as new age institutional investors.

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