When it comes to expat investing, the array of options available can be both exciting and overwhelming.
Among the plethora of investment vehicles, structured notes have gained considerable attention.
But what exactly are structured notes, and more importantly, should you consider investing in them?
Let’s dive in.
So, What Exactly Is a Structured Note?
Imagine you want to invest some money.
You’ve got options like stocks, bonds, gold or maybe even crypto.
But what if you’re looking for something a bit different?
Something that could give you the potential for higher returns, but with a safety net.
Enter the structured note.
A structured note is a type of investment that’s created by combining a traditional bond with another financial instrument (like options).
This combination allows for some creative outcomes, like the protection of your initial investment (to some extent) and the chance to earn more based on how well the stock market or a particular segment of it performs.
The Ingredients of a Structured Note
1. The Bond Part
This is what gives you the safety net.
Most structured notes have a bond component that promises to return the initial investment at the end of the note’s term, assuming the issuer doesn’t default.
This term could be a few years or more, so it’s somewhat of a long game.
2. The Derivative Part
This part is where things get more interesting.
Derivatives are complex financial instruments that derive their value from something else, like the performance of the stock market.
This component is what gives you the potential for higher returns.
If the market does well, you could earn more. If not, well, you’ve got the bond part to fall back on.
Why Would Someone Invest in One?
The appeal of structured notes lies in the potential for higher returns while keeping a part of your investment relatively safe.
They can be tailored to fit various expectations for market performance and risk tolerance.
For instance, if you think the market will go up but want some protection in case it goes down, a structured note could be designed to fit that exact scenario.
However, they’re not without their downsides.
The safety and potential returns come at a cost of complexity and fees.
Plus, your investment is as good as the company issuing the note; if they go under, so does your money.
Pros and Cons of Structured Notes
Pros of Structured Notes
1. Potential for Higher Returns
Structured notes often offer the potential for higher returns compared to traditional fixed-income investments, especially in low-interest-rate environments.
Their performance is tied to underlying assets, which can range from equities and indices to commodities, providing diverse opportunities for gains.
2. Customization and Flexibility
Investors can customise structured notes to suit their risk tolerance, investment horizon, and market outlook.
This flexibility allows for tailored strategies, such as capital protection, enhanced yields, or leverage, to optimise investment outcomes.
3. Access to Complex Strategies and Assets
Structured notes provide retail investors with access to complex strategies and assets that may be otherwise unavailable or too costly.
For example, they can offer exposure to foreign markets, commodities, or sophisticated trading strategies without the need to directly invest in those assets or markets.
4. Risk Management Features
Many structured notes come with built-in risk management features, such as capital protection levels, which can safeguard a portion of the principal amount.
These features can make them appealing to conservative investors looking for exposure to higher-risk assets.
Cons of Structured Notes
1. Complexity and Transparency Issues
Structured notes can be incredibly complex, making it difficult for investors to understand the risks and potential returns fully.
The embedded derivatives and conditional clauses may obscure the true nature of the risks involved.
2. Credit Risk
Investors in structured notes are exposed to the credit risk of the issuing financial institution.
If the issuer defaults, investors may lose their principal, regardless of the performance of the underlying asset.
3. Limited Liquidity
Structured notes are considerably less liquid than other investments.
They will typically have a set maturity date 3 to 5 years in the future and selling your note before, if possible at all, will be difficult and will likely result in significant losses.
4. Costs and Fees
Even though you are unlikely to be able to see them, the embedded costs and fees associated with structured notes can be high.
These costs can erode returns, especially in notes with complex features or multiple embedded derivatives.
5. Opportunity Cost
Investing in structured notes may result in opportunity costs.
The capital locked in these instruments could potentially earn higher returns if invested directly in the underlying assets or through other investment vehicles.
Conclusion
Structured notes can offer investors tailored investment opportunities with the potential for higher returns and risk management features.
However, their complexity, associated costs, and associated risks mean that they are unsuitable for most regular expat investors.
Get In Touch
If you are an expat considering investing in a structured note, or if you already have one, and would like an impartial second opinion, please get in touch for a free no-obligation 20-minute call.
