As part of an on-going effort to raise the public IQ on financial products, the SEC’s Office of Investor Education and Advocacy and FINRA jointly issued an investor alert called “Structured Notes with Principal Protection: Note the Terms of Your Investment” to educate potential investors of the risks associated with this particular. The retail market for structured notes has grown tremendously, and though they are often advertised as safe, they are by no means risk free.
A structured note generally combines a zero-coupon bond (a bond which pays no interest until maturity) with a related option or derivative. The asset, index, or benchmark underlying that derivative can vary widely, and the investor is liable the the change the value of that asset. However, in may instances their upside exposure (i.e. potential for profit) is capped.
Furthermore, though principal protected structured notes usually will bring the investor some return, the level of protection varies. Some guarantee is less than ten percent–and even a higher guarantee is only worth as much as the company making it.
Says the Director of the SEC’s Office of Investor Education and Advocacy: “Structured notes with principal protection contain risks that may surprise many investors and can have payout structures that are difficult to understand. This alert is a ‘must read’ for investors considering these products, especially those with the mistaken belief that these investments offer complete downside protection.”
Furthermore, the higher the potential yield, the more complex and potentially hazardous the investment. As FINRA Senior VP for Investor Education John Gannon notes, “The current low interest rate environment might make the potentially higher yields offered by structured notes with principal protection enticing to investors. But retail investors should realize that chasing a higher yield by investing in these products could mean winding up with an expensive, risky, complex and illiquid investment.”
