Understanding the Investment Protection Features of Structured Notes

Structured notes come in two different forms—growth or income. One thing that is common throughout structured notes is the principal or coupon payment investment protection features. Although there are variations with each note, they will typically use one of three protection features. These features can help investors protect some of their investments during down or volatile market cycles.

Common investment protection features

The first and most simple protection feature is the principal protected note. Although these can vary on how much of your principal is protected, I usually see 100% principal-protected notes. These are notes that, no matter what happens to the underlying index, will return all of your principal back to you at maturity. These are useful for a number of reasons. Do you need to protect your capital for a future need, but don’t want to miss out on some potential future gains? Do you believe we are entering a recession, but want to hedge that bet in case you’re wrong? Let me add that since these notes are fully protected, they will almost always have a cap on the maximum return you can realize. Remember, there is always a give for every take. This type of protection feature can complement a risk-averse investor with a well-diversified portfolio.
Another common downside protection feature often seen with structured notes is called a “buffer.” In essence, what this note will do is absorb a certain amount of loss of your principal if the index is negative at maturity. For instance, let’s say you purchased a structured note with a 15% buffer. At maturity, if the tracking index is negative -13%, you will receive 100% of your principal back. If, however, the tracking index is down -18%, your note will return -3% (18% minus the 15% “buffer”). This note can be ideal for someone who is willing to take on a little more risk, would like to participate in a rising market, but is still concerned about drawdowns.
The last of the most common investment protection features in notes is the “barrier” note. Similar to the buffered note, this one will return 100% of your principal if the tracking index is negative at maturity UP TO A BARRIER. If the stated barrier is breached, this note will participate in the drawdown 1 for 1 with the tracking index. For example, let’s say you’ve purchased a structured note with a 15% principal barrier. If the tracking index is negative -12% at maturity, you receive 100% of your principal back. Now, if the tracking index is down -18% at maturity, the note will also return -18%. Unlike the buffer note, in this instance, the loss is matched 1 for 1. These notes will usually offer the best upside potential since they carry more risk (give and take). For someone willing to take on more risk, they can potentially accelerate the growth rate of the tracking index (1.5x or more) or may pay out a higher coupon payment if it is an income note.

Match your investments to your goals

As always, structured notes have a stated trade date and maturity date. They will end at maturity unless they are “called” early (to be discussed later). The principal protection features (and the notes themselves) are backed by the full faith and credit of the issuer. Make sure you understand any investment fully before investing in it and if you invest in a structured note, make sure it matches your risk profile and financial goals.

If you have any questions regarding structured notes, feel free to reach out to us.

The views expressed represent the opinion of Good Life Asset Strategies, LLC. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness.