The good, the bad and the ugly on structured notes

April 18, 2015 / Knowledge Centre

Structured notes are an important part of the financial product assortment and some people love them whereas others hate them. Make up your own mind by familiarizing yourself with the good and the bad characteristics below:

The good: 

  • Protection
    The right structured note offers the investor the possibility to invest comfortably using the right combination of an attractive return and a high level of protection.
  • Predictable results
    Structured notes are very predictable investments, the risk-return profile is clear and all the conditions that determine the result of the structured note are known in advance. The issuing bank, the underlying assets to which the note links, the protection barrier, the coupon size and frequency are all known from the start. The only variable is the market-behavior of the underlying assets, but that is obvious.
  • Flexibility
    Some notes offer a low investment return with little or no principal risk. Other notes offer a higher return, even when markets are range-bound or go down moderately. Virtually any kind of structured note can be constructed using the many financial instruments available on the market today. The ‘ideal’ structured note therefore doesn’t exist and we encourage investors to discuss constructing their own structured note with Shoreline.

The bad?

  • Credit Risk
    All structured notes involve a loan to the issuer of the note. Therefore a structured note is only as good as its issuer. The investor bears the risk that the investment bank forfeits on the debt. A structured note adds a layer of credit risk on top of market risk.
  • Lack of Liquidity
    Lack of liquidity can be an issue in certain conditions. Many notes are bought and held until maturity or, in case of good performance, until early redemption on auto-call. In times of market trouble or a banking crisis, liquidity can dry up significantly. Under normal circumstances, the original issuer will buy back the note at the market value. This can be more or less than the originally invested amount depending on the performance of the underlying assets. We generally don’t recommend to trade structured notes unless absolutely necessary.
  • Pricing mechanism
    The pricing mechanism is not always based on the open-market valuation because most structured notes are issued in small tranches, sold to the investors and never trade after issuance. Prices are usually calculated using a matrix of variables including the current price of the underlying assets, the market volatility, the remaining term until maturity of the note and the potential of the accrued coupon payment taking place.
    The pricing of structured notes is done using computer algorithms that determine the ‘current’ price based on a snapshot observation. An algorithm is very abstract and free from emotions or human interaction. This can be a disadvantage as sometimes it may be hard to ‘understand’ for an investor why a note is priced the way that it is, however this also offers opportunities for investors that can add their ‘human’ intelligence to the pricing and find notes that offer above average yield potential at discounted prices.

Shoreline offers regular structured notes to clients via its many partners. If you would like to receive regular updates on structured notes all you need to do is to register on our mailing list. Contact us directly to discuss about investing in structured notes or if you wish to tailor a personal structured note.