These are instruments that invest in or reference various financial assets that exhibit certain volatility (they can decrease or increase in value constantly) with the aim of allowing the investor (client) to protect their investment capital or most of it against a drop or decrease in the value of those assets; on the flip side, that is, in the event of an increase in the value of the assets, the investor will receive a return agreed upon through a coupon or interest payment over a specified period.
In summary, it is an instrument that, in a scenario of market volatility, protects my invested capital, minimizing potential losses, and in the event of a market rise, provides me with attractive returns.
These instruments are generally marketed by wealth and private banks, as they require high amounts to be purchased (an average minimum of $100,000 pesos to $500,000), and therefore are not as popular or promoted; in many cases, they are the crown jewel within the investment strategies of various financial institutions because they allow for a higher return than traditional fixed-income instruments such as promissory notes or treasury certificates, investing in assets such as commodities, stock market shares, indices, Forex (other currencies), ETFs, and with terms ranging from 12 months to 72 months.
The appeal of the notes is based on obtaining the highest return with the least possible risk, which makes it the most attractive instrument in any investment advisory.
HOW DO THESE STRATEGIES WORK?
They operate on the principle of risk diversification, meaning that the manager or administrator of the note (usually investment banks) assumes the risk with the client through the protection of invested capital: if the investment achieves returns, the client will earn the agreed percentage, and the bank or investment manager will also earn.
To put it in simpler terms, it’s as if we wanted to invest in a business, if we do it alone, we run a higher risk of loss, but if we seek to partner with someone else who can provide capital and experience, the chances of benefiting from that investment are much higher; if it’s not a profitable business, I would get back my invested money or most of it. In conclusion, my worst scenario is to recover my invested money or most of it, and the best scenario is to achieve the desired return and share it with my partner.
Next, we will present a note advised by Grupo Hedeker, which explains how various clients have obtained returns from these instruments.
The note we will describe invests in the purchase of shares of 3 different companies: NVIDIA (the world’s largest semiconductor company), GOOGLE (the tech giant), and MICROSOFT (Another big tech); technically speaking, we will call them “underlying assets”.
The shares were purchased at the closing price on March 25, 2022, and were as follows:
The minimum investment was $10,000 USD (approximately $200,000 MXN); with this amount, shares of the mentioned companies were purchased.
In the table, we find two concepts: “coupon barrier” and “protection barrier” at a percentage of 65%, which means that if the price of the 3 shares remains above 65% of the purchase price (strike Price), the note manager will pay me a coupon or interest. However, if the price is below that value, I won’t receive any coupons.
We’ve described the main condition to earn a return of 9.50% annually (at the time, a higher yield than any fixed-term bank rate in Mexico). We should also note the duration of the note, that is, the months in which the money will be invested (in this case, it’s 24 months), meaning that during this period, my capital is invested: from March 25, 2022, to March 25, 2024, aiming to achieve a return of 19% during this period. To achieve this, the share price must exceed the “coupon barrier”, and every 3 months a review of the share price is conducted. If the condition is met, the corresponding quarterly coupon payment is made, which is 2.38%.
WHAT HAS BEEN THE RESULT OF THIS INVESTMENT?
The outcome has been positive for savers, who, as of the last review on June 26, 2023, have generated interest of 11.875%. This translates to $1,875 USD for every $10,000 invested over a period of one year and three months, outperforming a Mexican CETE, especially considering that it’s also a dollarized rate.
To corroborate the above, we show the graph illustrating the instrument’s performance:
As can be seen in the graph, the stocks of companies fell below the protection barrier from March 25, 2022, until January 2023, resulting in the failure to earn the coupon. However, due to the “memory effect”, it was possible to recover the coupons in March 2023 with a value of 11.88% of the investment, whilst maintaining the initial capital intact.
WHAT WOULD HAVE HAPPENED HAD THE INVESTMENT BEEN MADE WITHOUT THIS INSTRUMENT?
Quite possibly a catastrophe with significant losses, given that the average of the 3 stocks, in December 2022, had fallen in value by around 40% of the investment. This equates to approximately $4,000 USD for every $10,000 invested. In contrast, with the structured note, the fall with protection was only around $500 USD, and with the possibility of recovering that fall and earning the yield months later – which indeed occurred, instilling confidence in these instruments.
Investors who have this instrument in their portfolio will have their initial capital returned plus a yield of 14% (higher than the yield of US treasury bonds or Mexico’s CETE) and, conversely, would be at a loss or would have missed out on earnings.
For any additional topics related to economics, markets, and personal finance, contact me directly via:
Email: agarcia@hedeker.com
LinkedIn: Alberto García Medina
HEDEKER GROUP is a consultancy firm specialized in international investments, aimed at educating, protecting, and growing the wealth of savers and investors in our country. Consult us to learn more about what we can achieve.
