Structured Notes: A Complete Guide to Structured Products

Structured products occupy a unique position in the investment landscape. They are neither pure equities nor pure bonds — they are engineered combinations of the two, typically including a derivative component, designed to create specific payoff profiles that neither asset class alone can provide.

At their best, structured products solve genuine investor problems: they can provide market participation with capital protection for retirees, deliver regular income with defined downside conditions for yield-hungry investors, or give access to specific market views with precisely calibrated risk. At their worst, they are opaque, expensive products sold to investors who do not fully understand the conditions under which they can lose money.

Understanding the full range of structured product types — and the hidden cost that every one of them carries — is essential for evaluating whether any particular product serves your interests.

This guide is for educational purposes only. Structured products are complex financial instruments. The capital at risk in some products can result in substantial or total loss. Products described are illustrative. Tax treatment depends on individual circumstances. Seek independent professional advice.

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The Structure of a Structured Note

All structured notes share a common architecture: a debt obligation from the issuing bank, combined with a derivative that creates the desired payoff profile.

A simple capital-protected note can be decomposed as follows: the issuer takes £100 of your investment and uses approximately £75-85 to buy a zero-coupon bond that will grow to exactly £100 by the maturity date (typically three to six years). The remaining £15-25 is used to purchase a call option on the reference index. If the index rises, the option gains value, delivering the participation in upside. If the index falls, the option expires worthless — but the zero-coupon bond ensures you receive £100 back.

This decomposition makes the embedded cost visible. The theoretical "fair value" of the product is the sum of the zero-coupon bond plus the option at market prices. The actual terms offered to the investor are slightly worse — lower participation rate, lower cap — representing the bank's profit and distribution margin.

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Capital-Protected Notes

Capital-protected notes guarantee the return of the principal at maturity, regardless of what the underlying reference asset does. The trade-off is a portion of the potential upside, plus the opportunity cost of the deposit rate foregone during the term.

Worked example: A five-year capital-protected note linked to the FTSE 100, with 80% participation in upside.

• You invest £100,000.
• If the FTSE 100 rises 40% over five years, you receive £132,000 (£100,000 capital + 80% of 40% = 32%).
• If the FTSE 100 falls 30% over five years, you receive £100,000 — your capital is returned in full.
• If interest rates on a five-year deposit were 4% per year, you have foregone approximately £21,700 in interest (compound). This is the real "cost" of the protection.

Capital-protected notes are most appropriate for investors who need certainty of capital return at a specific date — retirees targeting income from assets they cannot afford to see fall below a threshold, or investors approaching a specific liability (school fees, property purchase) who want market participation without full downside risk.

The counterparty risk caveat is essential: the protection is only as good as the issuing bank's ability to honour the obligation at maturity. In 2008, notes issued by Lehman Brothers became worthless — capital "protection" that did not protect. Diversifying across multiple issuers and using highly-rated banks (AA/A rated) mitigates but does not eliminate this risk.

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Autocall Notes (Auto-Callable Structured Products)

Autocall notes are among the most widely distributed structured products globally. They offer enhanced income in exchange for specific downside conditions.

A typical autocall structure works as follows:

• Term: up to five years.
• Reference: FTSE 100 (or other index).
• Observation dates: annually.
• Autocall condition: If the index is at or above its starting level on any observation date, the product automatically redeems — you receive your capital plus a predetermined annual income (commonly 7-12% per year).
• If not called: The product continues to the next observation date.
• Barrier: If the index is below a certain level (commonly 50-60% of starting level) at final maturity, you receive back an amount linked to the index fall — you lose a proportionate amount of capital.

Worked example: Five-year autocall on FTSE 100, 8% income per year if called, 50% barrier.

Year 1: FTSE 100 at 95% of starting level. Not called. No income. Year 2: FTSE 100 at 102% of starting level. Called. You receive £100,000 capital + £16,000 (8% × 2 years). Total: £116,000.

Or, alternatively: Year 5: FTSE 100 at 45% of starting level (below the 50% barrier). Capital is linked to the index: you receive £45,000 — a loss of £55,000 on a £100,000 investment.

The barrier is the critical risk element. A 50% barrier means the investor is protected unless the index falls by more than 50% from its starting level. The FTSE 100 fell approximately 45% during the 2008-9 financial crisis. During COVID in March 2020, it briefly fell around 35%. A sufficiently severe market dislocation can breach even a 50% barrier.

Autocalls are appropriate for income-seeking investors who understand and can absorb the specific barrier risk, who have a medium-term investment horizon, and who want structured exposure to an index they have a broadly neutral or positive view on.

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Barrier Notes and Reverse Convertibles

Barrier notes and reverse convertibles are generally higher-income, higher-risk products where the capital protection element is absent or conditioned on the underlying staying within a specific range.

A reverse convertible pays a high fixed coupon (often 10-15% annually) and returns capital if the underlying asset stays above a specified level. If the underlying falls below that level (the barrier), the investor receives a reduced capital return or shares in the underlying at a fixed price — often less than they paid.

These products are more appropriate for sophisticated investors with specific views on the stability or range of an underlying asset. They have been criticised for being marketed aggressively to yield-hungry but insufficiently sophisticated investors, particularly in retail markets.

Participation notes provide straight index exposure with some enhancement — for example, 120% participation in the upside of an index with no downside protection. These are useful for investors who simply want enhanced directional exposure without introducing barrier conditions.

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Index-Linked Deposits

Index-linked deposits are capital-protected products offered by banks as deposits (rather than securities). They function like capital-protected notes but are classified and regulated as deposits — often covered by deposit protection schemes up to the relevant limit.

The participation rates offered on index-linked deposits are typically lower than on structured notes, reflecting the additional cost of deposit protection and the different regulatory treatment. Nevertheless, for investors who value the deposit protection backstop, the slightly lower participation may be a worthwhile trade.

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The Fee Structure: Understanding Embedded Margin

Unlike funds, structured notes do not disclose an explicit ongoing charge or annual fee. The provider's profit is embedded in the terms of the product.

The fair value of a structured product can be estimated by decomposing it into its component parts (zero-coupon bond + option) and pricing those components at current market rates. The difference between this theoretical fair value and the terms actually offered is the combined margin of the manufacturer, distributor, and any intermediaries.

For retail structured products, this embedded margin typically ranges from 1-5% of invested capital over the product's life — equivalent to 0.2-1.5% per year on a five-year product. This is comparable to actively managed fund charges, but is not visible to investors without specialist analysis.

Accessing structured products through a regulated adviser who analyses term sheets and negotiates competitive terms from multiple issuers is the most effective way to reduce embedded margin.

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Counterparty Risk: The Unseen Risk

Every structured note is a debt obligation of the issuing bank. If the bank becomes insolvent during the product's life, holders rank as unsecured creditors. Capital protection within the product becomes meaningless — you receive a share of the bank's remaining assets in administration, potentially pennies in the pound.

This is not a hypothetical risk. Lehman Brothers structured product investors learned this lesson acutely in 2008.

Risk mitigation approaches include:

• Use only investment-grade issuers (minimum A-rated; preferably AA-rated).
• Diversify across multiple issuers. Never concentrate a large structured product portfolio with one bank.
• Monitor issuer credit quality. CDS spreads and credit ratings provide real-time signals of deteriorating bank credit.
• FSCS-eligible products. Some structured products and index-linked deposits fall within FSCS protection — confirm eligibility before investing.

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Global Distribution and Access

Structured products are widely available through:

• Private banks (available to clients with £250,000+ investable assets, often as primary issuance from the private bank's treasury)
• Independent financial advisers and wealth managers (offering products from multiple bank issuers)
• Platforms (some online investment platforms provide access to listed structured products)
• Directly from specialist providers (Tempo Structured Products, Walker Crips, others in the UK market)

Structured notes are particularly widely used among HNW clients in Asia (Hong Kong, Singapore), the Middle East, and Europe. They are less common in the US retail market due to different regulatory and tax treatment.

For internationally mobile investors, structured products issued under English law or through offshore financial centres are typically accessible regardless of residency, provided the investor meets the suitability requirements of the relevant jurisdiction.

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How Global Investments Can Help

Global Investments provides access to primary issuance from multiple structured product manufacturers, allowing clients to compare terms across issuers and ensure they are receiving competitive embedded margins for the structure they need.

Our advisers can analyse specific term sheets, explain payoff conditions in plain English, and assess whether a particular product genuinely addresses a portfolio need — or whether a simpler, lower-cost combination of existing instruments achieves the same objective.

For clients who have received structured product recommendations from a private bank or platform, we offer independent second-opinion analysis of the terms and embedded costs.

Contact Global Investments to discuss whether structured notes have a role in your investment strategy.