The democratization of finance is centered around building tailored portfolios for each client. It’s said that annuities are like the Swiss Army knife of portfolio management: They can be used to help meet a variety of personal finance goals, particularly aiding in retirement planning.
But have you considered another tool that can serve an even broader client base?
Structured notes are gaining steam as a vehicle that can be used to construct customized investment plan solutions beyond the power of annuities. Working in the fintech space, I’ve seen how competition and technology have brought costs down considerably for today’s notes, allowing more investors, regardless of portfolio size or sophistication, to harness their power.
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By incorporating notes in a portfolio, advisers can better help clients stick to their short- and long-term planning goals and secure a brighter financial future. By improving the investment experience, structured notes can smooth out the rough patches that bear markets often bring.
Build on what you already know and understand
Sure, advisers have an array of ways to put notes to work, but with a little context and a client-first strategy, you’ll see why notes are growing in popularity (opens in new tab).
Consider that structured notes are almost always just stocks, bonds and options. You know this stuff, and explaining it to clients may be easier compared to outlining the risk characteristics of today’s growing alternative investment universe. You don’t have to tell them how the sausage is made.
For starters, structured notes are issued by banks and are designed to offer investors a degree of downside protection. In the U.S., high-net-worth investors and private banks catering to those individuals have been using them for years, but thanks to competition and technology, now financial advisers can harness the potential benefits of notes for the average investor or client.
A client-first investment plan with structured notes
For instance, let’s say you have a client working in the technology industry with significant stock options and shares awarded by an employer. An adviser could request a growth or income note that homes in on other stock market sectors to diversify the portfolio. Another option would be to purchase an income note that focuses on downside protection and high yield in the tech space if the investor still desires a concentrated allocation to technology.
It’s important to distinguish a growth note from an income note. This is a key way to manage risk.
Growth notes. Risk-seeking investors may want to go this route. The performance is tied to the price appreciation of an index. Enhanced upside is possible — meaning if the index rises 20% in a year, the growth note could be 24% (or 120% of the index’s return). “Soft protection” with a growth note allows for greater upside potential. You can even use a growth note on a very volatile basket of stocks to speculate on possible big-time returns. But this approach is not for everyone.
Income notes. Risk-averse clients, or those with a shorter time horizon, are likely more comfortable with income notes. A focus on yield and a defined maximum loss amount helps folks sleep better at night compared to owning other assets. As with growth notes, income notes can be used to express various market sentiments and are highly customizable. Income notes usually feature higher yields than traditional bond funds, and their coupon payments are often contingent on the performance of the underlying asset.
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The two types of protection
I mentioned “soft protection” earlier. Soft protection is like a downside barrier: If an index drops 10% and a note’s soft protection amount is 15%, then the holder loses nothing. But if the index declines 20%, then the investor is exposed to all the losses. Put simply, it’s a more aggressive type of protection compared to “hard protection.”
Hard protection acts like a buffer, in that the investor experiences only losses beyond the protection amount. So, if the underlier is down 20% and the hard protection is 15%, then the note holder is down just 5%.
Know the fees and risks
To be clear, as with any investment, structured notes present unique risks and considerations. For starters, investors should not ignore fees. Relative to other risk mitigation techniques, structured notes can be more cost-effective, but to truly appreciate value, investors need to know their fees.
And while a robust secondary market exists, structured notes lack relative liquidity. They also come with credit risk. Because structured notes are issued by major banks, it’s important to understand that investing a note means accepting some credit risk.
Defined outcome investing helps achieve financial goals
Investors demand more control of their financial future. Defined outcome investing is here to stay. Structured notes can be a powerful tool to execute a personalized portfolio plan across client types.
Getting started is easy. I find that clients (and advisers) are often comfortable taking a slice of a standard stock or bond allocation and reallocating that amount to notes. That way, it is not a seismic shift, but a modest step toward more effective portfolio management that puts the investor’s goals front and center.
In the current market, many of the gains are coming from the same stocks. To build an optimized portfolio, structured notes can help you and your clients build better asset allocation strategies. Just as an outdoorsman can whip out his Swiss Army knife to tackle challenges in the wilderness, today’s adviser can leverage the many capabilities of notes to meet the growing needs of retail investors.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.