For clients looking to maximize their savings for retirement, structured investments can be a helpful tool.
Structured investments, also known as structured notes, are a combination of a bond, which can provide downside protection, and a derivative, which provides leveraged upside benefits, allowing investors to limit risk and potentially increase returns. The derivative's performance is linked to an underlying asset, such as an index or individual stock.
A late 2023
Structured notes can be linked to the performance of a variety of underlying assets including equities, commodities, currencies, interest rates and credit.
The upside potential provided by structured notes allows investors to pursue riskier investments while protecting against losses during market declines.
"Don't drive a car without insurance; don't invest without insurance," said Jason Barsema of
The rise of structured notes
While structured notes have been popular for decades in Europe and Asia, greater awareness about the products is boosting their popularity in the United States. An August 2023 study from Cerulli Associates found that the investment vehicles were "
READ MORE:
This May, New York-based fintech
In the past year, CAIS has partnered with Phoenix-based firm
Ashton Lawrence, a senior wealth advisor with the Greenville, South Carolina branch of
"This makes them a compelling alternative as well as they can be a strong complement to traditional bonds and equities, particularly for investors concerned about market volatility and looking for a more predictable income stream or growth potential," he said.
Considerations
When considering whether a structured investment is an appropriate choice, advisors should weigh the creditworthiness of the issuer, availability of principal protection, call risks, potential fees, liquidity and tax implications.
Potential users of structured notes should be aware that liquidity is often only available once the note reaches maturity. As there is no exchange on which to sell structured notes, selling notes before maturity can be difficult (though some structured notes may be traded on a secondary market).
"Liquidity is always there, but you have to understand that you only get the full benefit of the protection in the upside at maturity," said Barsema.
The construction of structured notes also eliminates the ability to receive dividends.
While most notes are not FDIC-insured, some platforms, like Halo, offer FDIC insured notes.
Structured notes have historically only been available to wealthier, often institutional investors. However, platforms like Halo Investing offer lower-cost structured notes that can be more accessible to retail investor clients.
There are four main types of structured notes: income, growth, digital and absolute.
Income notes, which replace the coupon of a fixed income security with a customized cash flow, can be an alternative to traditional fixed income notes.
As with all investment products, advisors should consider structured notes as one piece of a diversified portfolio.
Barsema warns that although structured notes contain a bond component, they should not replace bonds in portfolios. Instead, he recommends that up to 30% of portfolios be dedicated to structured notes, with the rest going to traditional securities.
The case for boomers
As older clients approach retirement, advisors typically recommend they increase allocations to bonds. However, bumping up allocations to structured notes is another strategy to consider.
"I think these products can be very powerful within a boomer's portfolio, because they can provide yield, they can provide enhanced upside, but more importantly, they can provide protection because they truly cannot afford to lose their money," said Barsema.
Tom Balcom, founder of Lauderdale-by-the-Sea, Florida-based RIA
"They can keep clients invested during volatile times and prevent clients from making emotional decisions in regards to their portfolio," said Balcom about the advantages of the notes.
Lawrence said that as long as predefined market conditions are met, clients can receive steady cash flow through the notes with coupon rates as high as 11% annually.
Kenneth Nuttall, chief investment officer of West Grove, Pennsylvania-based
While Barsema said that structured notes have particular incentives for boomers, he asserted that ultimately, they are a tool fit for any client.
"I would argue that they're appropriate for everybody, but even as an advisor, if they're not appropriate for you, you should learn about them, because other advisors are, and they're going to be speaking to clients about them," said Barsema.
Balcom agreed, and said, "They are ideal for all clients who want to sleep well at night."
Advantages
Advisors can customize structured notes to meet clients' individual needs. By adjusting notes for specific outcomes related to growth, yield, protection, risk-reward profiles, and market views, advisors can help clients optimize the growth of their savings.
"They can be whatever you want them to be. It's just a wrapper," said Barsema.
Online investment platforms that offer structured notes allow advisors to create terms, including what underlying asset a note is attached to and the maturity date. Thus, structured notes can provide clients with exposure to a variety of markets and asset classes.
Unlike some alternative investments, there are increasingly structured notes which have no investment minimums or accreditation requirements for purchase by retail investors.
READ MORE:
Brandon R. Opre, founder of Huntersville, North Carolina-based RIA
"Investors have definitely gotten complacent with this 10-plus year bull market and are probably unprepared for major pullbacks. Notes provide some buffer and insulation from pullbacks," Opre said.
Structured notes can offer attractive returns during periods of high interest rates, which can lift the bond's yield, and high volatility, which can enhance the pricing of the derivative component.
"Ultimately, right now is a really good time to buy structured notes, because interest rates are still high, so you're getting the benefit of that in the pricing of your structured note," said Barsema.
Starting out
Barsema recommends that advisors start out by allocating 5% to 10% of their portfolios to structured notes tracked to the S&P 500 that have principal protection, meaning that investors will receive at least the amount they paid for the note once it reaches maturity.
"It's as vanilla as it gets. It's as conservative as it gets. And that way, you have an easy explanation to the client," he said.
Lawrence said that structured notes should be used only after the advisor fully understands the potential advantages and disadvantages to using them.
"Structured notes can be complex and may require thorough understanding and professional guidance for the retail investor," he said.
Barsema recommends starting with one sleeve of the portfolio, such as U.S. large capitalization companies.
"Get educated, take the time to learn, and then make your own decision," he said.
