Trolling my first “Financial Advisor” Part 2 of 3 – Structured Notes

Hi RIP Friends,

This is the second post in a short three posts series about my experience with a Financial Advisor. Your can read first post here, where I explained how I was cold contacted on LinkedIn, and what happened during our first 1h-long video call.

Let’s call The Advisor’s consulting company MCDD, which is not its real name.

The Advisor sent two Structured Notes factsheets to me few weeks after our call. She claimed that these notes were issued exclusively for MCDD customers, and that they were especially suited for this “uncertain market times”. But it was an obvious lie. As we’ll see, the two Notes she shared with me perform way better in low volatility environments. Also, the notes were created exclusively for MCDD customers but… MCDD is never mentioned in the factsheets! Not a great start.

I received the factsheets a couple of days before the October meetup with fellow Mustachians in Zurich, and discussed the products with my dear friends Mr. Cheese an Julianek, in front of a (couple of) Beer(s). I thank them for their inputs and the interesting conversation 😉

Also note: the Structured Notes subscription deadline was end of September, and I received them after the deadline… maybe she intended to just show me the “kind” of products, not the actual ones she wanted me to invest in. I don’t know, I forgot to ask. Again, not an amazing start. She was supposed to be a professional with 20+ years of experience in giving financial advices.

Another thing to note is that I received the Factsheets, but not the actual Prospect Documents. Sadly, the Factsheets don’t mention fees and other nuances and technicalities of the investment, which could be a place where the devil hides. Like currency conversion fees, reference currency, asset currency, call risks, and so on.

I won’t tell you much about my conversation with the Advisor like I did in the previous post, it wasn’t a deep conversation. I showed my perplexities to the Advisor in our follow-up meeting and she quickly moved on trying to sell my the next crappy product, the Insurance Policy Pillar 3A/B that we’ll see in next chapter.

I kind of regret having been so direct with her in this second meeting. I would have loved to see the Prospect documents, shame on me for not having gone for it. This post would have been much richer if I had gone close to sign a concrete proposal.

Anyway, I how you enjoy this deep analysis of the Structured Products I’ve ben offered.

Have fun, and let’s get started! 🙂

What is a Structured Note?

The best definition I’ve found is the following, from a Singaporean government agency website:

A structured note is a debt product whose return is linked to the performance of one or more underlying assets or benchmarks. It may be the interest that is payable on the structured note and/or the principal repayment, that is linked to the performance of the asset or benchmark.

(also check the Investopedia definition here)

Essentially, you’re buying a debt obligation with a financial institution (usually an investment bank) that we’ll call the issuer. You lend your money to them, and expect a future cash flow that depends in a nonlinear way on the performances of a basket of assets.

I know, it’s complicated, and this should already be a yellow flag.

It’s complicated for the average investor, but not for someone who likes to think in bets, and who adopts a probabilistic thinking approach in financial decision making. In the end it’s not rocket science, but average people should never ever ever EVER invest a Dollar on products like these, because you should not invest in what you don’t understand, right?

Ok, good.

There are infinite types of Structured Products, you can essentially reproduce whatever risk/return profile you want. In this post I can’t possibly cover every single type of structured product. I’ll just analyze the actual Notes the Advisor shared with me.

If you want to know more, I recommend the Structured Retail Products website.

RIP Notes

They offered me two similar products. Two notes with the same structure and reward profile.

Both of them had the following structure:

• I invest X USD (or GBP, never CHF) in their product before the given Strike Date.
• The product defines a Final Valuation Date (4-6 years), i.e. the duration of this debt obligation.
• I will get Quarterly or Annually coupons (very high, 10-17% annual yield) if the price of the lowest performing asset in their basket is above a Trigger Value (95-100% of Strike Price).
• At the Final Valuation Date I will get back 100% of my principal if the lowest performing asset price is above the Protection Barrier (70% for both Notes). Else I will get the performance of the worst performing asset.

Plus there are two other features (Autocall and Memory) that I will explain while analyzing the first Note.

Simply stated:

• You get quite high “dividends” (10% or above) if none of the assets in the basket performs particularly bad.
• You don’t get any upside benefits if some of the assets perform exceptionally well.
• You get the downside effects of the worst performing asset in case it performs particularly bad.

Here follow a few consideration before we take a look at the actual Notes.

First thing that comes to my mind is: you want to have a small basket. You’re linked to the worst performing asset in the basket, so the less they are the better it is for you.

Let’s assume a Protection Barrier of 70%. If you have a basket of 4 stocks, and 3 of them perform spectacularly well but one drops by 50% you’re doomed. You won’t get any coupon, and the capital returned to you at the Final Valuation Date is 50% of your initial investment.

What happens if one of the assets goes to zero? You guessed it right: you’re screwed even if the others were Tesla, Domino’s Pizza, and Bitcoin 🙂

You have to eat the worst apple in your basket. The more apples in your basket, the easier it is that one is rotten.

Second, you want correlated assets in the basket.

Let’s assume 20% of the world population don’t like RIP Pizza (how dare you!!). And let’s assume that the likelihood of a person craving for RIP Pizza is correlated with their culture, their eating habits, the fact that their circle of friends like RIP Pizza or not. So you get “clusters” of people who like RIP Pizza and clusters of people who don’t. Maybe we discover that RIP Pizza is very popular in Indonesia, but it’s hated in the Philippines.

What are the likelihood that taking a sample of 10 people in the world everybody loves RIP Pizza?

If you take 10 random people, despite the fact that RIP Pizza is incredibly popular (80% of people loves it), there’s only a ~10% chance that each one of the 10 random people loves it, i.e. 0.8^10 ~=10.7%.

What if instead of taking 10 random people in the world, you randomly select just a person, and then take the remaining 9 people in the same neighborhood (same culture, maybe close families, maybe friends)? What are the odds of all of them loving RIP Pizza?

Well, taken to the extreme, if you take 10 people who have the exact same opinion (correlation = 1) the odds that all of them like RIP Pizza become 80%! Same odds of an individual liking RIP Pizza.

And if you’re the cook who’s been told “You’re fired if I find even a single person that doesn’t like your Pizza among the next 10 customers“, trust me: you want the highest correlation possible 😉

I think this is crucial in understanding this kind of products.

Third, what about anti-correlated assets?

They’re a death sentence for your Note.

Having assets that “if X goes up, Y goes down” in your basket, and having your performances linked to the worst performing asset is a suicide strategy.

Like having a basket of 3 Pharmaceutical companies racing for a Covid vaccine (yep, take a look at my second Note)

Brace yourself, Notes are everywhere!

Yeah, three tech companies in a winner-takes-all industry, after an incredibly long bull market 😉

I think this is the way to bring dumb money to the table, and let the asset bubble explode.

Pump and Dump is coming, babe!

Anyway, let’s take a look at a concrete example, my first Note:

Note 1: Yearly 10-11% Coupons, Basket of 4 Stock Indexes

Before we even start: who am I dealing with?

This Note was issued by a Canadian Bank (CIBC), and proposed to me by the Advisor, who works for MCDD, the consulting company. The factsheet is produced by an intermediary brokerage firm (that I censored here) that, on their website, “seeks to add value to our institutional clients’ investment decisions“, i.e. there’s another middleman who’s going to take a cut.

How many middlemen there are? This is another thing to keep in mind: in a low yield world, any hand who comes to grab a 1-2% or more is going to kill your returns.

This Note is offering a 11% yearly coupon in USD, or 10.25% in GBP. It a very high dividend. You’re not getting such a “passive income” from your Dividend stocks, or from your S&P500 ETF.

As you can see it’s a tempting proposition: in a low yield world, where people and their financial advisor & retirement planners are craving for a “fixed income” solution that guarantees a 3-4% per year, a solution that promises a 10%+ return catches a lot of attention.

Plus if the excrement hits (gently) the ventilating system you still get 100% of your principal back, since the Protection Barrier is 70%. It means that even if each one of the 4 assets in the basket loses 29% of their Strike Price, you’d get 100% of your principal back.

Sounds good, right?

Well, it’s much more complicated, and the “good parts” of this Note end here.

Let’s take a look at the return of the Note compared to the return of the worst performing underlying asset, assuming the Final Valuation Date was just one year later:

As we saw, below the Protection Barrier (70% of the Strike Price) your Note performance is the same of the worst performing asset.

The range between 70% and 110% is very interesting: you get better performances than the worst performing asset: between 70% and 100% (the Trigger value) you still get 100% of your invested capital, and above 100% you get 110% (capital + coupon), which is a better return than the worst performing asset (if it performs no better than +10%).

You don’t get any extra benefit if the worst performing underlying asset performs better than +10%. If it doubles, you get only the 10% coupon. It has limited upsides. But not a bad limit, we’re talking about 10.25% in GBP (or 11% in USD).

Let’s enlarge the picture to take into account 10x and a 1/10x performance of the worst performing asset. Let’s imagine the worst performing asset is a company like Tesla, that could easily 10x (been there, done that) or be decimated:

Yep, now it sucks… you get all the negative effects, but if your asset “10x”s you only get +10%.

Here’s the logscale, where you can better feel the pain of the negative returns:

Mind that I don’t think the underlying/return profile is bad per se.

You know what? I’d take it if we were talking about a single, low volatility asset like an Index! I’d take this profile on S&P500 anytime you offered me!

I expect a yearly return on S&P500 to lie somewhere between -50% and +50%, with an historical average nominal return of +10% (there are more positive years than negative ones).

No wait, the historical 10% return for S&P500 is the nominal average total return of the index.

It’s important to mention that the underlying assets of this Note are NOT total return indexes, they’re just indexes. They get partially smashed by dividends. While S&P500 total return historical average nominal return has been 10%, the historical average return of the S&P500 has been 8% without dividends. We don’t get any dividend by owning the Note, and the reference performances are not accounting for dividends! Very bad.

Fun fact, the Note issuer is incentivized to discourage companies stock buybacks programs, and maybe suggest them to distribute larger dividends 🙂

Anyway, as I said I would invest in a Note with the above profile on a basket of a single asset with low volatility like the S&P500, especially in this – in my opinion – inflated scenario.

The medium-long Duration of this Note (6 years) reduces the probability of falling below the Protection Barrier of 70%, and the Memory feature will provide me all the returns I’ve eventually missed while the Note was under water. Where should I sign?

The problem is that they’re not offering me this Note on a basket of a single low volatility asset. The basket is composed of 4 indexes:

• FTSE100: Market Cap Weighted 100 largest companies in UK.
• Euro Stoxx50: Market Cap Weighted 50 largest companies in EU.
• ASX200: Market Cap Weighted 200 largest companies in Australia (funny, 200 from AUS, and only 50 from EU).
• Nasdaq100: Market Cap Weighted 100 largest companies listed in Nasdaq Stock Exchange (mostly Tech stocks).

What’s the problem with this basket?

First of all, it’s a large basket! There are 4 assets… the likelihood that the worst performing won’t hit the Trigger Value (or would fall below Protection Barrier) is non-negligible.

Second, they’re uncorrelated. They had to play hard to find uncorrelated assets in a global market, but we can assume Australian, UK, EU, and US Tech stocks are as uncorrelated as large cap stocks can be. It could have been worse, like adding “small cap indexes” in the basket (small cap stocks are less “global”, so geographically separated markets are less correlated), but it’s already enough of a bad deal.

Third, their currencies are uncorrelated. EUR, GBP, USD, AUD. Let’s not forget that your “worst performing asset” will be measured in a reference currency (GBP or USD), while the assets in the basket are tied to the whole set of 4 currencies! This increases volatility, which is bad for our Note. Ok, this is partially mitigated by the anti-correlation between currency performance and the large cap index in the same market (since profits made abroad are worth more in local currency). If the AUD drops 50% compared to USD it’s more likely that the ASX200 companies make good profits abroad and that the index goes up by a lot (in AUD). Anyway, your Note is measured in USD or GBP… if the USD goes up (when? when???) the odds of an Australian or European, or UK index not meeting its strike value (in USD) grows.

Fourth, this is a Structured Note whose underlying/return profile is suited for a neutral market, and I have trouble considering current stock market “neutral”. According to Structured Retail Product Academy there are products for bullish markets, bearish markets, neutral markets, and for several goals like capital protection, yield increase, leverage, and so on.

So far, not so good.

But there are two features that could make the Note look a little bit better: Memory and Autocall.

Memory

The Memory feature means that if at an observation date, i.e on every Note’s Birthday, the worst performing asset’s price is below Trigger Value (100% of its Strike Price, according to this Note’s Factsheet) you don’t get the coupon but the coupon itself is not lost (yet): it’s accumulated somewhere. Once/If the Trigger Value is met (at an Observation Date, not infra-dates), you get paid all the coupons you missed.

Ok, not bad. Kudos.

Autocall

The Autocall feature means that if at an Observation Date the Trigger condition is met (worst performing asset above 100% of strike price), the Note would redeem immediately, and you’d get back 100% of initial capital plus all the “memorized” coupons.

Cool, I won’t have to wait until Final Valuation Date!

This is a good thing, isn’t it?

Well, in theory it should be a good thing. You get all your money back (plus coupons) and then you decide if you want to invest in another similar product again. Of course maybe future Notes won’t be so generous with coupons, but the opposite might be true as well. Hard to tell.

In practice, this is a nice strategy for the middlemen chain to charge extra fees to you. You keep paying subscription and currency conversion fees every time you re-invest your money.

Imagine this realistic events flow:

• You have 100k CHF ready to be invested in this Note.
• Intermediaries take 2%, so only 98k CHF gets wired to the issuer.
• The issuer doesn’t know what to do with CHF, the Note is listed in USD. your 98k CHF gets converted in USD with another 2% currency conversion fee on the issuer side. You now have 96k CHF converted in USD (more or less 1 Billion USD) invested in this Note.
• Everything goes well, and one year later the Trigger Value is reached! Yay!
• They want to wire you 1.11 Billion USD, i.e. the original Billion plus the 11% coupon. Which is 106.5k CHF (96k + 11%), assuming USD didn’t lose another 10% compared to CHF in the meantime…
• On your bank account you only see 104.3k CHF, because your bank took another 2% currency conversion spread.
• Then tax declaration day comes, and they don’t give a crap about your double currency conversion losses. Your asset generated 10.5k CHF nominal profits (106.5k – 96k), and this profit is getting taxed as income (no Swiss tax-free capital gain), at your marginal tax rate, on top of your salary. Say 25-30%. Another 2.5-3k CHF gone.
• You end up with 102k CHF, a 2% Real Profit instead of the promised 11%

Mind that we’re assuming a stable CHF to USD conversion, and the worst performing asset in the basket closing the year above 100% strike price in the reference currency… this is an optimistic scenario!

Ok, maybe you’re Fin-savvy enough and you have a cheap way to handle USD or GBP directly, like I do: I have a USD denominated bank account with PostFinance, and I use InteractiveBrokers are a cheap currency conversion engine. So maybe you can skip the double currency conversion fees… but you won’t escape taxes and middlemen fees.

According to Mr Reset, who’s been scammed by the same advisor company (MCDD), they take 2% each. I see three entities involved in this Note. Maybe not all of them take a 2% fee (that would be outrageous), but I won’t be surprised to discover that the total intermediary fees add up to something like 3%.

So the Autocall feature might be a double trap: first trap is that you see the money immediately. You paid 100k, and after just one year you have 104-108k (before taxes) back. It feels good, so you buy Notes again, and buy more. Second trap is that you were promised 11%, you actually have to take into account intermediary fees, currency conversion fees, currency fluctuation risk, and taxes. It will be a miracle to keep half of the promised return, and we’re exploring the scenario where everything goes well on the performance side.

The overall conditional cash flow for this Note is the following:

They also added a backtest for this Note that goes back 16 years. Well, of course every structured product you’ll see would have performed amazingly on past data. I mean, this is the kingdom of cherrypicking, in both basket components and backtesting dates.

I bet there are entire datacenters running code to find and film someone who flipped 10 consecutive heads on a coin, and to build structured products on him 😀

I’m actually thinking that maybe basket components are picked just to look good in backtesting while granting enough confidence to the Note Issuer that things will go well for them.

Anyway… Before jumping to conclusion let’s take a look at the second Note.

Note 2: Quarterly 4.25% Coupons, Basket of 3 Pharma Stock

I won’t redo the entire analysis, since the two Notes are structurally similar. Let’s just look at the differences.

This Note promises an even higher coupon! It’s 17% per year! Actually it’s 18.11% per year if you take into account compound interest. I mean, if the Trigger Value is met each quarter, thanks to Autocall you can reinvest the original amount plus the coupon on each subsequent quarter, which leads to 1.0425^4 = 1.1811478… ~= 18.11%.

Plus, the Trigger Value is 95%, which means you’d get 100% of your invested capital and all the amazing coupons even if all the assets in the basket lost 5% of their Strike Price! Awesome, right?

And the basket is composed of just 3 assets, not 4! This is an amazing Note!!

Or… is it?

Sadly, the good news end here. Let’s take a deeper look:

• The basket is composed on 3 assets, but they’re Individual stocks. Individual stocks are more volatile than Indexes. Individual stock returns are skewed by few winners. Several studies have been made on the subject, including a famous one by JP Morgan in 2014 where over 13k stocks have been analyzed. The study shows that 40% of stocks suffer a decline of 70% or more and never recover… The Trigger Value of 95% is just an irrelevant illusion of safety. Take a look at this amazing video by Ben Felix.
• The individual stocks in the basket are over-inflated pharmaceutical stocks at their all-time high valuation. I don’t know if you noticed but there’s a pandemic going on, and pharma stocks have been very hot recently. Maybe it’s already too late.
• The stocks seem correlated (which would be good), but given the winner-takes-all nature of a Gold rush (Covid Vaccine), I’d bet their future returns will be anti-correlated. We’ll see it in the mini-backtesting section of this Note in Q4 2020.
• The Note duration is just 4 years. A longer duration would have helped in high volatility environment.
• Frequent Observation Dates might trigger more Autocalls, potentially incurring in more fees. Maybe they can’t totally kill your quarterly returns with currency conversions and middlemen fees, they need to play smarter. Maybe only taking a 1% fee (but 4 times a year) on each Autocall…

I regret so much not having moved further with The Advisor, and missed the opportunity to see the actual fee structure! I’m sorry  that I have to speculate on fees and not be factual 🙁

If anyone of you has extra details, please let me know!

“Ok, RIP, this Note is Riskier, but also the profits are higher! It’s called risk/reward frontier”

Yes, I know… But how can I quantify it? How can I price this product? How can I tell if the coupons are good or bad, given the other conditions?

“I don’t understand…”

Complexity

What I’m saying is that it is very hard to price this product.

By “pricing” I mean finding the values of the relevant variables that would make me buy the product.

I mean, if the quarterly coupons for the second Note would have totaled 100% instead of 17% I’d have bought the Note. What about 50%? What about 20%? I would have probably invested at 50%, but not at 20%… that means there’s a break-even value somewhere. How to find it?

What if the Protection Barrier was 20% instead of 70%? Then I’d buy the Note for sure! What if it was 50%? Mmm… I don’t know…

How to find the correct “price” for this product?

Let’s change the question, let’s invert: what’s the expected return for this product? Is it Pareto Optimal among all the available investing opportunities on the market? Can I find a set of assets that has a Pareto Superior risk/reward profile? Is the risk-adjusted expected return better than, for example, Earning Yields of the MSCI ACWI Index (currently 4.48%, since “World AC” CAPE is 22.3)?

I’m not even asking the “do I want to take this kind of risk?” question, which is purely subjective.

(Psst: take a look at this amazing Rational Reminder podcast episode with Ben Felix and William Bernstein, it’s mostly about risk, volatility, market expectations, age, and optimal portfolio based on these factors!)

I didn’t ask the above questions because I want to deep dive into the complex math behind expected returns for such products. It’s beyond the scope of this post, and probably beyond my current skills. And obviously it’s not solvable in closed form: you need a Monte Carlo simulation, along with models for expected future returns of underlying assets. No, it’s not beyond my skills!

I asked the questions to point out that you and me, average investors, don’t have the skills to judge if it’s a honest offer or not (before fees).

I intuitively think that it’s an inferior product in terms of risk adjusted expected returns, let alone my risk aversion that would discount risk even more, but I have no math to back my claim.

I’m much more confident in claiming that an actively managed US stocks fund with 10 years of underperformance history and a 2% TER is an inferior solution to Vanguard VOO, because the two are easier to compare.

My friend Julianek (who works in close contact with entities that issue such Notes) told me that they’re usually not unfairly priced, but the layers of fees on top will kill your returns. He said that the Autocall feature is there because they want to milk more subscription fees from you. My gut feeling is that they’re also mathematically inefficient, but this is pure speculation.

My First-Principles-Thinking reasons to claim the mathematical inefficiency are:

• Given the unicity of each structured products, it’s impossible for an individual to run an optimality analysis. And it’s easy for the issuer to run their simulations, discover that a coupon of 21% is the break even, and then offer a coupon of 17%. Who will ever complain? Who will ever find it out?
• Given the high “golden path” returns, retail investors won’t complain that they’re not higher. Nobody complains that the lottery prize is “only” 10M instead of 30M, even though the redistribution of lottery ticket sales among lottery winners is ~33% (in Italy at least).
• I assume the issuers (Banks) hedge and don’t play dice with these products.

I would like to spend few more words on the last point.

The Bank doesn’t play dice with the Structured Note

(Note: this is purely speculative. Please, change my mind if you have valid arguments 🙂 )

Structured notes are debt obligations. The issuer takes my money and uses it whatever they likes. Like if I subscribed a bond with them.

Let’s assume the issuer is taking my money, hiding it under a mattress, and crossing their fingers in the hope that the Trigger Value is never reached until Note’s Expiration Date.

Is this a good strategy? Are they just betting? Playing a Russian Roulette with me? I don’t think so.

Why would they take the same (high) risk that the Note carries with it?

My model for Note’s issuers (banks) is that they’re rather conservative. Banks are conservative. Now, I don’t know much about this CIBC bank… but it’s one of the Big Five banks of Canada, I assume they must play safe.

So, what are they doing with my money to hedge the risk?

At the very minimum they’re investing it in a low risk / low reward instrument, aiming to a low yield (say 2-3%) and still crossing their fingers. If the Notes are efficiently priced, on average they should win.

But this is still risky: in case the Trigger Value is reached they need to give me back a 10-17% return. As far as I know they don’t run charities – or when they do I’m not one of the beneficiaries but an involuntary contributor!

So they probably want to use my money to build a portfolio with a return profile that mimics the one they’re offering to me. Bonus points if it’s Pareto Superior, i.e. if for every possible outcome their strategy holds non-inferior returns compared to the Note’s obligation.

In this case they simply arbitrage between me and a set of more efficient products, making a profit with zero risk. Maybe using a combination of bonds, stocks, and derivative products (stock options, futures…) they can build a Pareto Superior return profile.

if this is true, and in my opinion this is very likely, that means the Note is mispriced for me, the unaware retail investor, even before fees and hidden costs.

Another hypothesis is that they’re simply gambling the system on a larger scale, like a Ponzi Scheme. They’re gambling like crazy, and if the castle of cards crashed they go belly up – or they ask for government support (like Italian banks). Head they win, tail government bails them out. Or worse, creditors bail them in.

Are they playing this game? Should I take into account credit & counterparty risks?

Hint: you always should when lending your money.

Anyway, I believe this second strategy is less likely to be the dominant one.

Other Random Problems with Structured Notes

Credit/Solvency risk: the issuer may default.

Underlying assets defaulting: if the product has some specific link to underlying assets, and one of the assets goes bankrupt, the issuer might not repay the principal. See structuredretailproduct.com for more details.

Illiquidity/Untradeability: Notes rarely trade on secondary markets, which means if you want to sell your investments before maturity you’ll have a hard time.

Call risk: according to the SEC and to Investopedia “for some structured notes, it’s possible for the issuer to redeem the note before maturity, regardless of the price. This means it’s possible that an investor will be forced to receive a price that’s well below face value“.

Conclusions

Structured Notes with the analyzed profile (there are infinite kinds of structured products) are risky and tax inefficient investment tools that carry limited positive but unlimited negative consequences.

The actual purchase of these instruments via a brokerage-like consultancy firm will bring extra more-or-less-hidden fees into the equation, that will make the investment even worse.

Structured Products are complex investment tools that make pricing and understanding risk not feasible for a retail investor, as also stated in the Factsheet:

I therefore recommend you not to invest in these tools, unless you’re really aware of what you’re doing, the risk you’re taking, and the fees you’re paying.

But if you have the required skills to judge the quality of a Note, you can probably build an alternative, derivative-based portfolio with a Pareto Superior return profile, and show the middle finger to the middlemen.

Bonus: What if I invested in those Notes?

What if I decided to buy the two Notes by end of September 2020? How would I be performing today, December 21st 2020?

Let’s see what I would have gained so far!

Note 1

All the four indexes are above 10% their strike price in their currency (which gained at least 5% compared to USD). This means probably the worst performing index in USD is the Nasdaq100, which is “only” up 11.3% compared to its Strike Price of September 30th 2020

Ok, we’re far from Autocall Trigger (end of September 2021), but if nothing else would happen for another 9 months we’d get the 11% (in USD) coupon (minus fees and taxes).

Which is less than what the market returned during last 3 months! VT is up 14.43% since September 30th. A 14.43% capital gain (not taxed in Switzerland).

So… inefficient!

“But RIP, you’re investing in USD Bonds…”

Sssh, shut up! Next!

Note 2

We’re close to the first Quarterly Observation Date (end of December 2020), can we cash the 4.25% USD coupon (while the USD lost 3.75% vs the CHF in the meantime)?

How are the three pharmaceutical stocks performing today?

Pfizer is kicking asses 🙂

What about AstraZeneca?

Ouch, it’s a -11.5% in GBP (-7.4% in USD). It’s below Trigger Value 🙁

What about Sanofi?

Oh, no! It’s at -7.2% in EUR… but in USD it’s just -3.2%! Above Trigger Value! Yay!

Sadly what matters is the worst performing asset, so maybe we’re going to skip the December 30th observation date, and “memorize” the coupon for next quarter.

In the meantime we should cross our fingers that AstraZeneca recovers, while Sanofi doesn’t lose an extra 2% and the USD keeps going down…

Who would have thought it! In their 16 years of backtesting the Note performed amazingly! 😀

Who would have guessed that these stocks were anti-correlated during a vaccine gold rush?

Hint: everyone.

Bonus Conclusion

Both Notes were inefficient, and I had superior available alternatives – that I didn’t take anyway, but that’s another story.

It’s a high volatility market, and this Structured Note’s profile is suited for “calm, sideways markets”.

It’s a highly inflated market, a double digits drop for any asset is behind the corner, especially for individual stocks, especially for stocks with high expectations like pharmaceutical companies during a pandemic.

Think twice trice ten times before buying these products.

External Resources

Investopedia article “Why Structured Notes Might Not Be Right for You”

Structured notes are complicated and are not always designed to be in the best interests of the average individual investor. The risk/reward ratio is simply poor. The illustrations and examples provided by investment banks always highlight and exaggerate the best features, while downplaying the limitations and disadvantages. The truth is that on a historical basis, the downside protection of these notes is limited, and at the same time, the upside potential is capped. Now add the fact that there are no dividends to help ease the pain of a decline.

If you choose structured notes anyway, be sure to investigate fees and costs, estimated value, maturity, whether or not there is a call feature, the payoff structure, tax implications, and the creditworthiness of the issuer.

SmartAssets article “What Are Structured Notes and How Do They Work?“

A structured note can open up myriad opportunities for investors. A disreputable institution or a wary bond issuer can slam all of them shut. Be aware of the considerable risks before considering this particular investment.

If you feel your portfolio can withstand the risk for the potential rewards that structured notes can provide, they may be worth considering. However, if you’re approaching structured notes with any trepidation, consider seeking some impartial advice.

Investments for Expats article “Structured Notes: What You Need To Know As An Expat”

Money Sense (Singaporean Government Agency) article “Understanding Structured Notes”

A detailed article by the SEC (US Securities and Exchange Commission) about “Structured Notes with Principal Protection”

The retail market for structured notes with principal protection has been growing in recent years. While these products often have reassuring names that include some variant of “principal protection,” “capital guarantee,” “absolute return,” “minimum return” or similar terms, they are not risk-free. Any promise to repay some or all of the money you invest will depend on the creditworthiness of the issuer of the note—meaning you could lose all of your money if the issuer of your note goes bankrupt.

Also, some of these products have conditions to the protection or offer only partial protection, so you could lose principal even if the issuer does not go bankrupt.  And you typically will receive principal protection from the issuer only if you hold your note until maturity.  If you need to cash out your note before maturity, you should be aware that this might not be possible if no secondary market to sell your note exists and the issuer refuses to redeem it.  Even where a secondary market exists, the note may be quite illiquid and you could receive substantially less than your purchase price.

That’s all for today 🙂