A Quick Overview
Structured notes are investment products issued by financial institutions that are typically built using a zero-coupon bond combined with embedded options on a market index, such as the S&P 500.
A Typical Example
Consider a 13-month structured note linked to the S&P 500 that offers a 10% coupon and a 15% downside buffer. If an investor allocates $10,000 to this product, the outcome after 13 months depends on how the S&P 500 performs.
Scenario 1 – The S&P 500 is flat or up
The investor receives a flat 10% return ($1,000) plus their $10,000 principal, regardless of how much the S&P has increased — even if it rises 100%. They forgo any upside beyond the 10% coupon.
Scenario 2 – The S&P 500 is down 15% or less
The investor still receives the 10% return ($1,000) and their $10,000 principal back. The downside buffer protects against moderate losses.
Scenario 3 – The S&P 500 is down more than 15%
No coupon is paid, and the investor absorbs losses beyond the 15% buffer. For example, if the index drops 30%, the investor could lose approximately 15% of their principal. (In some cases, the loss may accelerate depending on the note’s specific structure.)
How Structured Notes Are Typically Positioned
Structured notes are often marketed as a hybrid between equities and bonds, offering more potential return than traditional fixed income but also more risk. A 10% contingent coupon may appeal to an investor unimpressed by a 4% treasury yield. However, it’s important to recognize that the additional return comes with significantly greater risk.
Although some view them as bond alternatives, structured notes often behave more like the underlying equity index. In fact, some institutions refer to them more broadly as “structured products” to distinguish them from conventional bonds.
Key Risks and Considerations
While structured notes can offer attractive features, they come with a range of trade-offs that investors should fully understand before investing. The following risks highlight why these products require careful evaluation, especially in comparison to more traditional fixed-income or equity investments.
Credit Risk
Structured notes are obligations of the issuing financial institution. If the issuer defaults or faces financial stress (as seen during the 2023 regional bank crisis), investors may face partial or total losses.
Liquidity Risk
These products are generally intended to be held to maturity. Early liquidation may result in losses, depending on market conditions and buyer interest.
Market Risk
Structured notes are sensitive to market volatility. Returns are based on the value of the underlying index at maturity. meaning even consistent performance during the term can be wiped out by poor timing at the end. For example, many structured notes linked with U.S. investments that matured in March or April 2025 wouldn’t have been paid out, because the equity market was down in the final month of maturity (even though they were “in the money” the whole time until then).
Complexity and Cost
While the basic concept of structured notes can be explained, the actual mechanics — including pricing and payout — involve complex option strategies. Investors typically pay for this complexity through embedded costs.
Whether fees are included in “net of fee” pricing or charged separately in managed accounts, total costs typically range from 1.25% to 1.50% annually.
In Conclusion
Investors should carefully weigh time horizon, risk tolerance and desired return before investing in structured notes.
Remember, if a 10-year Treasury note offers a 4% “risk-free” return, a 10% structured note implies a 6% risk premium. This means the investor is rewarded by 6% for the risk they’re taking. However, after accounting for fees (potentially reducing risk premium to around 4.5%), investors must evaluate whether this additional return adequately compensates them for the risks and complexities involved.
