Structured Investment Solutions.
Structured Investment Solutions.
Structured Notes – A key building block in an investment portfolio
Traditionally the diversification offered by balancing equities and bonds in a well-structured portfolio was enough to ride out market volatility; with the one offsetting the other during tough times. But in an uncertain environment, in which these polar opposites are becoming decidedly more correlated, there is a need for a new hybrid asset class. Structured notes are filling the void.
Structured notes can provide flexible return and protection options, targeting a level of expected returns over a defined time period. Structured products can offer capital protection, yield enhancement and upside participation – providing a middle ground between bonds and stocks.
While structured products date back to the 1990s, where they emerged out of the UK, these pre-packaged debt securities were initially the preserve of institutions and high-net-worth investors. Only fairly recently have specialist firms made them more widely available, driving up global demand to around US$2 trillion in assets under management.
LNKD Investment Managers offers a new portfolio construction building block: income notes. A lower-risk subset of the relatively new structured notes category.
What’s the attraction?
Structured notes offer a hybrid, tucked between equities and bonds, which offers the best of both worlds from a performance perspective and a risk-mitigation element. They comprise a bond element together with an embedded derivative and, typically, fall into two categories: growth notes (which participate in upside returns) and income notes.
Lower-risk income notes offer a conditional payment – or coupon – over the life of the note and have in-built downside protection. They work very well with traditional assets and play a very specific role in portfolios. Income notes are not used for massive outperformance but rather offer a steady Sterling or US dollar return for our client portfolios.
Ultimately the aim is to create more certainty around returns, particularly during times of market unpredictability.
The inner workings of Structured Notes
- Coupon: Interest which is paid out on a quarterly, semi-annual or annual basis.
- Maturity: Duration can range from six months to over a decade. LNKD predominantly works with six-year notes.
- Developed market reference indices: Since the payment of the coupon depends on the stability of an index, LNKD use developed market indices, specifically the likes of the FTSE100, Euro Stoxx50, Nikkei and S&P 500.
- Issuer: Structured notes are issued by major financial institutions. The creditworthiness of the deposit holder is essential.
- Barrier: At predetermined intervals the issuing bank determines if any of the chosen indices have dropped by more than a predetermined amount such as 30%. If not, investors receive their coupon. However, if one index had dropped below the 30% barrier then the coupon will not be paid.
- Memory feature: This risk mitigate feature kicks in if a coupon payment is missed due to a barrier breach. It means that if a coupon is missed it can be made up again at a future observation date when the indices are back within their respective barriers.
- Back testing: LNKD runs around 2 500 tests and simulations to highlight the potential for performance across a range of market conditions, outlooks and variables.
Simple and Liquid
Once you understand the jargon, these products are both remarkably simple and liquid. Returns across different scenarios are clear and there are no lock-ins. All products are liquid and are priced every day, although ideally the product is designed to be held for the full term.
LNKD partners with leading experts in the field, bringing two structured notes to market every month, in both pound sterling and US dollars.
There can be a number of pitfalls with notes, so you have to be very careful to build the notes properly – from senior debt to the right barriers, issuers and indices. Structured notes span the risk spectrum and range from low risk to very high-risk notes linked to single name stocks. LNKD focuses primarily on lower risk notes. Ultimately, we are looking for stability, increased certainty of income and levels of downside protection, which is key in terms of risk and which offers appropriate returns. Risk is at the forefront of everything we do.