The good, the bad and the ugly on structured notes

April 18, 2020 / Knowledge Centre

Structured products are an important part of the financial product assortment. Some investors love them, whereas others hate them. Make up your own mind before you invest in structured notes and familiarize yourself with the following advantages and disadvantages:

The advantages of structured notes:

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, because all the conditions that determine the outcome of a structured note are set 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.

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. It is possible to construct virtually any kind of structured note using the many financial instruments available on the market today. The ‘ideal’ structured note therefore doesn’t exist and we encourage investors to discuss the advantages of constructing their own structured notes with Shoreline.

The disadvantages of structured notes:

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. Investors normally buy and hold notes until maturity or, in case of good performance, until early redemption on auto-call. In times of market trouble liquidity can dry up significantly and prices will come under pressure. 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:
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. Computer algorithms determine the ‘current’ price of structured notes and it isĀ  always a snapshot observation. The algorithm is very abstract and free from emotions or human interaction. Sometimes this is a disadvantage and it is hard to ‘understand’ for an investor why a note is prices the way that it does. However this also offers opportunities for investors that can add their ‘human’ intelligence to algorithm pricing and find notes that offer above average yield potential at discounted prices.

Find out more:

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. Click here to check out our FAQ on terminology used for structured notes