What are Structured Notes?
Structured Notes are investments which often combine securities of different asset classes as one investment for a desired risk and return over a period of time. They are complex investments that are often misunderstood by not only investors but the financial advisors who recommend them.
Structured notes are manufactured by financial institutions in all sizes and shapes. Generally, a structured note is an unsecured obligation of an issuer with a return, generally paid at maturity, that is linked to the performance of an underlying asset, such as a securities market index, exchange traded fund, and/or individual stocks.
The return on the structured note will depend on the performance of the underlying asset and the specific features of the investment being made. The different features and risks of structured notes can affect the terms and issuance, returns at maturity, and the value of the structured product before maturity. They may have limited or no liquidity before maturity. Before investing, you better make sure you understand the terms and conditions and risks associated with the structured note being offered.
Structured Notes Specifics
Structured notes are often represented as investments being guaranteed by large financial institutions. Indeed, the top issuers of structured notes in 2021, Goldman Sachs (12.75%), Morgan Stanley (12.70%), Citigroup (12.46%), J.P. Morgan (11.92%), UBS (80.47%), Credit Suisse (4.99%), RBC (4.45%), Bank of America (3.90%), Scotiabank (3.89%), are some of the largest financial institutions in the world.
It’s important to understand that although the benefits of owning structured products may be guaranteed to be paid by one of those large financial institutions, the amount of interest or principal being guaranteed is dependent upon the features of the product being sold; that is, the specific terms and conditions of the investment contract being purchased.
In this low-interest rate environment the most popular structured notes being offered are structured notes with principal protection and income features. Some of the structured notes offer full principal protection, but others offer partial or no protection of principal at all.
Some structured notes offer higher rates of interest that may be paid monthly and then suddenly stop paying any interest at all because payment was contingent upon certain events not happening. It all depends on the terms and conditions of the investment contract being purchased, which is why you must read the term sheet or better yet the prospectus to understand the nature, mechanics and risks of the structured note being sold.
Structured Notes Features
You need to understand that there are many key terms beyond the words “guarantor” and “guaranteed” which are used often to describe structured notes. You need to ask about and be sure to understand the following features of the structured notes being offered:
- the nature of the “reference asset” (a/k/a the “underlyings”) the reference index(es), ETF(s), or stock(s) underlying the structured note.
- whether the “reference asset” gets put to you at maturity (delivered) or you get paid in cash and forced to realize a loss.
- the “barrier levels” which can dictate the payment of interest and/or return of capital to the investor in the structured notes.
- whether the notes “auto-callable” which might force you to realize permanent loss that might not otherwise have occurred if you were allowed to hold the securities through market fluctuation.
- the “redemption dates,” or “observation dates, ” which may impact the amount of payment of principal or interest you ultimately receive.
- whether the interest payments subject to a “contingent coupon” and, if so, be sure you know the contingency parameter and the level where your interest payments may stop.
- How the “closing value” and/or “final value” of the “reference asset (as)” are calculated on the “redemption date(s)” or “observation date(s).”
Talk to an Attorney Before Investing in Structured Notes
Structured notes are a type of investment that can offer higher returns than traditional investments, but they also come with more risks.
If you’re thinking about investing in a structured note, it’s important that you understand how these products work before making a decision.
Robert Pearce, Attorney at the Law Offices of Robert Wayne Pearce, P.A. is a highly experienced investment fraud lawyer who has successfully handled many structured note cases and other complex securities and investment law matters. He will explain structured notes in more detail below this image.
Investment Losses? We Can Help
Discuss your legal options with an attorney at The Law Offices of Robert Wayne Pearce, P.A.
or, give us a ring at (800) 732-2889.
What are the Different Types of Structured Notes?
There are different types of structured notes, but they all have one goal in common: to give the investor a higher return than what they would get from a traditional investment, like a savings account or government bond.
Structured notes can be created with different underlying assets, including stocks, bonds, commodities, and even currencies. The most common type of structured note is the principal protected note, which is designed to protect the investor’s original investment while still offering the potential for growth.
Underlying Asset Categories of Structured Notes:
Index: The performance of a selected index is used as a reference asset for some structured products. An index is a statistical measure of change in a securities market and the particular index selected varies by product and issuer. The S&P 500 and Dow Jones Industrial Average are two well known examples, but narrower types of indices may be used, such as those relating to particular sectors or regions.
Currency: A selected group or basket of currencies whose weighted average is used as a reference asset for some structured products. The number of and particular currencies selected vary by product and issuer. The Euro and Yen are examples.
Commodity: A selected, basic good or group of goods whose value is used as a reference asset for some structured products. The type and number of commodities selected vary by product and issuer. Grains, gold, oil and natural gas are examples.
Interest Rates and Yields: Bond indices, yield curves, differences in prevailing interest rates on shorter and longer-term maturities, credit spreads, inflation rates and other interest rate or yield benchmarks are used as a reference asset for some structured products.
Other types of structured notes include:
- Equity-linked structured notes: These structured notes earn returns (dividends) based on the performance of stocks. This can be an individual stock or a group of stocks.
- Credit-linked structured notes: These notes are specific to the credit risks or events that organizations, such as companies, experience.
How do Structured Notes Work?
Structured notes are created by banks and other financial institutions. The issuer of the note will bundle together different types of securities, such as stocks, bonds, and commodities. The way these assets are bundled together will create the desired risk and return for the investor over a period of time.
All structured notes have two parts: a bond component and a derivative component.
Most of the note is invested in bonds for principal protection, with the rest allocated to a derivative product for upside potential. The derivative product investment allows exposure to any asset class.
It’s important to remember that a structured note is a debt obligation. The issuer of the structured note typically pays interest or dividends to the investor, similar to a bond, during the terms of the notes. This makes this type of investment seem safe and secure to many investors.
However, there is always the potential for loss with a structured note. Structured notes suffer from a higher degree of interest rate risk, market risk, and liquidity risk than their underlying debt obligations and derivatives. If the issuer of the note defaults, the entire value of the investment could be lost.
This means that if the issuing bank were to go bankrupt, investors could lose their entire investment.
How are Structured Products Categorized?
The structured product market can encompass many variations and the appropriateness of each issue should be evaluated by its specific terms. Most issues can be categorized by one of the following headings.
Principal Protection: Principal protected structured products may be more appropriate for conservative investors seeking market exposure with principal preservation. These typically offer full principal protection at maturity with the potential for additional return based on the performance of an underlying asset or group of assets. Investors may forfeit some upside exposure to an underlying asset in exchange for principal protection. Return of principal may not be obtained if the investment is sold prior to maturity. Principal protection and payment at maturity are subject to the credit risk of the issuer. The creditworthiness of the issuer is an important factor to consider in investing in a principal protected note. Certain principal protected notes have differing levels of protection; some, for instance, do not offer 100% principal protection. Please note that principal protection applies only to nominal principal and does not offer inflation protection.
Enhanced Yield: Enhanced yield structures may be appropriate for more risk tolerant investors seeking higher returns than comparable debt instruments. Payment at maturity on these short-term notes is determined by the performance of an underlying asset or group of assets and principal may be at risk. Investors generally forfeit partial or full principal protection at maturity in exchange for the potential to earn a higher participation. Investors can be exposed to downside risk and may lose part or all of their original investment. Additionally, investors may receive shares of stock at a value below the original principal amount at maturity. Coupon payments and payment at maturity is subject to the credit risk of the issuer.
Access: Structured products can provide investors with access to an asset or group of assets not readily available to private investors. These products can offer exposure to markets or strategies that may be inefficient or difficult for investors to obtain, such as foreign exchange rates or commodities. Since these products may not provide for full repayment of principal at maturity and are typically linked to sophisticated underlying assets, they may be more appropriate for moderate to aggressive investors.
Leverage: Structured products that utilize leverage may be generally more appropriate for aggressive investors wanting to capitalize on a particular market view. These short-term products provide partial or no principal protection but do offer the potential to receive leveraged returns on the value of the underlying asset. Some structures may offer additional leverage in exchange for capped or limited upside potential. Investors are exposed to downside risk of the underlying investment and may lose part or all of their original investment.
Structured products, principal protected or otherwise, may not be appropriate for all investors.
Additional reading: What are Steepener Structured Products and How we Can Help With Losses
Complex Variations of Structured Products
Beyond the direct linking of an underlying asset class as a dictate of return, some structured products include varying features and specifications that may impact performance. Barrier structures, for example, place parameters on the upside and downside performance of an underlying asset. During the noted observation period, which may be a day, a set period of time or for the life of the contract, if the value of the underlying asset exceeds an upper barrier or falls below a lower barrier as specified by the issuer, an investor may be exempt from any gains or losses on the investment.
For any complex variations that may be present with a particular offering, discuss the performance parameters with your Financial Advisor.
Pros: What Are The Advantages of Investing in Structured Notes?
The versatility of structured notes allows them to provide a wide range of potentially lucrative outcomes that are difficult to come by elsewhere.
Structured notes typically offer investors returns that are higher than the interest rates offered on traditional deposits. They may even offer the potential for capital appreciation.
However, such gains or capital gains are subject to the performance of the underlying reference asset(s) or benchmark(s), which exposes investors to a wider range of risks than with a traditional deposit.
IMPORTANT: Structured notes are often considered too risky and complicated for the individual investor. Unfortunately, the promise of greater commissions in recent years has prompted stockbrokers to push structured notes on investors, including those for whom they were unsuitable, too dangerous, or just not in line with their objectives.
Related Read: Can I Sue My Financial Advisor For Structured Note Investment Losses?
Cons: What are The Disadvantages of Investing in Structured Notes?
Investing in structured notes may not be suitable for everyone. The main reason is that they are complex products that are often misunderstood.
A vast majority of structured notes are not principal-guaranteed.
You may lose all or a substantial amount of the money you invested in certain situations, including if the reference asset or benchmark performs poorly, interest rates rise, or the issuer of the note defaults as outlined by the terms of the product.
The principal repayments or the dividends payable, or both may be linked to the performance of a referenced asset, which is often highly volatile. As a result, if the referenced asset underperforms, you may suffer the loss of dividend payments and/or the loss of your principal investment.
In addition, the issuer may have the right to call back, or redeem, the notes early, which could also trigger a loss of your investment.
What are the risks?
An investor will be exposed to a greater variety of risks when investing in structured notes than when investing in traditional products such as deposits.
An investor will lose money if:
- The underlying asset or benchmark underperforms
- The issuer exercises its call option and defaults
Although structured notes have the potential to generate greater returns, investors also assume more risks. Investors may find themselves confused by the complex terms and conditions associated with structured notes.
To make matters worse, some issuers have been known to market their products aggressively, without adequately disclosing the risks involved.
In some cases, investors have lost all of their money after investing in structured notes.
IMPORTANT: Structured notes may be suitable for somebody but not everybody. Structured notes have a high degree of risk, and the loss of all or a substantial portion of your investment is a real possibility. Investors should only invest in structured notes if they are willing and able to lose their entire investment.
More details: The specific risks of structured products/notes
Can I Sue for Structured Note Investment Losses?
Yes, under the right circumstances. You may have a claim if your broker or advisor recommended structured notes when they were unsuitable for you, or if the broker failed to disclose the risks involved.
You most likley have a legal claim if you have investments losses due to one or more of the following reasons:
- The nature, mechanics, or risks of the structured note were misrepresented.
- The financial advisor failed to provide you with a prospectus, offering memorandum, or otherwise disclose all of the material risks of the structured product investment.
- The recommendation that you invest in a particular structured note was unsuitable.
- Your account was over-concentrated in structured notes which may otherwise have been suitable for a small percentage (10% or less) of your portfolio.
Investment Losses? We Can Help
Discuss your legal options with an attorney at The Law Offices of Robert Wayne Pearce, P.A.
or, give us a ring at (800) 732-2889.
Can I Recover my Structured Note Investment Losses?
Potentially Yes! At The Law Offices of Robert Wayne Pearce, P.A., we represent investors in all kinds of structured note investment disputes in FINRA arbitration and mediation proceedings.
The claims we file are for fraud and misrepresentation, breach of fiduciary duty, failure to supervise, and unsuitable recommendations in violation of FINRA rules and industry standards. Attorney Pearce and his staff represent investors across the United States on a CONTINGENCY FEE basis which means you pay nothing – NO FEES-NO COSTS – unless we put money in your pocket after receiving a settlement or FINRA arbitration award.
Contact Us for a Free Initial Consultation
The Law Offices of Robert Wayne Pearce, P.A. have highly experienced investment fraud lawyers who have successfully handled many structured note cases and other securities law matters and investment disputes in FINRA arbitration proceedings, and who work tirelessly to secure the best possible result for you and your case.
For dedicated representation by an attorney with over 40 years of experience and success in structured product cases and all kinds of securities law and investment disputes, contact the firm by phone toll free at 800-732-2889 or via e-mail.
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