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How to Implement Structured Notes During Volatility

Written by: Jason Barsema | Halo Investing

Every day, it seems like the market is offering attractive entry points, and yet every other day, the market seems to be "limit down or limit up." Volatility has arrived in global markets. These are trying times indeed, but in my opinion, this is not a solvency or liquidity issue by the Banks, which is one of the important things to consider when assessing the true risk of this downturn.

With this in mind, Structured Notes can provide relief in the portfolio for a few reasons. We’ve seen significant demand to invest in these volatile times from the Advisor community, even given this market volatility.

1. Structured Notes can give Advisors the confidence to put money to work

This is due to the fact that Structured Notes offer a level of downside investment protection so Advisors can worry less about catching a falling knife.

In these markets, it's hard to tell where the market is going right now, but Halo has seen particular demand over the last 48 hours for Growth Structured Notes with both Hard and Soft Protection (see our post on the trade-offs between the two protection types).

As a reminder, Growth Structured Notes can offer a level of downside investment protection from market declines, while allowing investors to participate in a specified participation rate on the upside.

Growth Structured Notes can be a great way to allow Advisors to enter an uncertain market like this. These were the exact tools I was using in my portfolios at Credit Suisse during 2009. They helped build my business in fact as they made my clients feel very comfortable deploying cash in a very uncertain environment.

To this point, our Advisor community is seeing this as an opportunity to put money to work. In the event the Advisor is early, there is still comfort in knowing they have the downside investment protection. (We're seeing 25-30% protection levels being popular right now.) This also makes the Advisor's conversations with clients much easier, as clients are rightfully scared, yet don’t want to miss out on the eventual rally.

For those that already have Structured Notes in the portfolio, Advisors should look to ease their clients' concerns by reminding them this is the very reason they implement downside protection in the first place.

Advisors may also want to consider some tax loss harvesting by selling "long equity" exposure and rolling that into a Structured Note that offers some attractive and enhanced upside, with the comfort of a cushion on the downside. This is what I have recently implemented for a portion of my family’s personal assets.

2. Structured Notes can be a great way to "lock in" high volatility

With the VIX closing in on near all-time highs, one can only remember the Financial Crisis.

While this corona-crisis is very different, Advisors should look at this as an opportunity to "sell vol" by buying a Structured Note with Soft Protection. With Soft Protection, the investor is selling options (premium) to generate the downside protection versus buying premium with Hard Protection.

These are some of the most attractive terms in the 12 years that I have been utilizing Structured Notes. If you haven't used them before, now is the time to strongly consider them.

The higher the volatility, the deeper the protection and higher participation / yield you will get. Locking in volatility is also a great action item to discuss with your clients in regards to how you're taking advantage of the current market environment.

3. Some of the most attractive terms on income-oriented structured notes since the Financial Crisis

In 2009, I used Structured Notes in the depths of the Crisis to add some protection to the portfolio in case the market kept falling. More importantly, I could get incredible upside participation when the market eventually recovered.

While past performance is not indicative of future results, we certainly see this as a time to take advantage of the Bear Market.

My clients loved knowing the fact they could get this enhanced upside while still adding a level of protection on the downside against future declines. It was a double bonus. While this is not 2008/2009, I believe we will all be glad we put money to work when we fast forward 12 months.

With this in mind, pandemics are virtually impossible to model.

By no means do I believe the stock market pain is over, but there is a case to be made that a bottoming process is forming. Again, pandemics are virtually impossible to model.

This is exactly why I have been buying Income Structured Notes which provide an annual fixed return, paying out as a quarterly coupon. These are contingent upon either of three separate equity indexes falling 30% during the quarter.

I have been buying these over the last week and will continue to buy as the yields look very attractive in my opinion. They also help me achieve my investment objectives in what could be a sideways market for a longer period of time.

As an example, the above mentioned Note was yielding 8.6% per annum on February 26th. As of today, March 17th, the same Note is yielding about 25% per annum. This is an incredible jump in yield. Moreover, the Note comes with 30% downside principal protection from here. I have the personal thesis the market will not be down another 30% from these levels, and for all of our sake, let's hope not!

In sum, now is the time Advisors need to be thinking about how best to take advantage of the quick and significant decline in the equity markets while making the conversation palatable with very nervous clients. Structured Notes may be an attractive way to do so.

Related: The Stock Market Crash Was Inevitable, but Stimulus Will Fuel Another Bull Run