- This article details the advantages and disadvantages of indexed products and structured notes, emphasizing why there is no simple answer to the active vs. passive investment debate.
- It is aimed at asset managers and investment advisors seeking to build comprehensive strategies and offer more robust solutions to their clients.
- At FlexFunds, we securitize assets to issue exchange-traded products (ETPs) that enhance diversification and liquidity in investment strategies. For more information, feel free to contact our team of experts.
In the realm of asset management, when the active vs. passive investment debate arises, structured notes and indexed products are often highlighted as two of the most comprehensive financial instruments for building integrated strategies. However, it is essential to understand that they are not the same, and each has its own advantages and disadvantages.
What are structured notes?
Structured notes are financial instruments that combine features of both fixed-income and equity products.
According to the U.S. Securities and Exchange Commission (SEC), these notes are issued by financial institutions and sold to investors through intermediaries.
Specifically, structured notes are securities with a fixed term, typically less than a year, based on the issuer’s conditions. Their performance is tied to the basket of underlying assets they represent.
Advantages
Structured notes offer the following benefits for asset managers:
Customization
Portfolio managers can provide a completely tailored solution aligned with each investor’s goals and needs, as the basket of underlying assets can include stocks, bonds, commodities, currencies, etc.
Controlled risk
Risk in structured notes can be controlled, as these instruments often include a portion of fixed-income assets to protect against significant price fluctuations.
“Certain Structured Investments may offer full or partial market protection on your initial investment if held to maturity,” notes JP Morgan.
Disadvantages
Despite their advantages, structured notes also come with drawbacks, leaving the active vs. passive investment debate without a clear winner:
High complexity
Unlike other financial instruments, structured notes are highly complex. Since they are composed of various assets tailored to a specific strategy, only experienced managers can structure and sell them to clients.
“You and your broker should take time to fully understand the manner in which your return on a structured note is calculated. You should understand the reference asset(s) or index(es) and determine how the note’s payoff structure incorporates such reference asset(s) or index(es) in calculating the note’s performance,” explains the SEC.
What are indexed products?
On the other hand, indexed products, which are increasingly popular in the market, are financial vehicles that replicate the performance of a specific asset index.
For example, the SPY exchange-traded fund (ETF) tracks the performance of the S&P 500 stock index, while the GLD fund emulates the spot price of gold.
Advantages
According to Morningstar data, indexed funds are expected to represent 70% of the total fund market, significantly outpacing active funds, over the next decade due to two major benefits:
Diversification
By acquiring a single indexed product, investors or asset managers can access a highly diversified portfolio spanning dozens, hundreds, or even thousands of different assets.
For instance, with the SPY fund, a single purchase provides access to the weighted performance of the 500 largest and most important companies in the U.S. market.
Low costs
The widespread adoption of indexed products has significantly reduced their costs. On average, these funds charge an annual fee of just 0.5%, compared to 1% or 2% annually for actively managed funds.
Disadvantages
However, these benefits come with a clear downside:
Market returns
By definition, indexed funds cannot generate returns higher than the index they track. In other words, the performance of these financial vehicles is limited to market behavior.
Those seeking higher returns and aiming to “beat” the market will need to choose professional active management. While the fees are higher, they are theoretically offset by the greater returns achieved.
Structured notes vs. indexed products
Understanding the advantages and disadvantages of structured notes and indexed products allows us to determine whether one option is better than the other.
The reality, as with the broader active vs. passive investment debate, is that it all depends on the goals and needs of investors and asset managers.
The best investment management specialists and financial advisors, who aim to deliver the most favorable outcomes for their clients, often opt to create strategies that combine both types of financial instruments.
To optimize the reach, distribution, and liquidity of these strategies, they use exchange-traded products (ETPs) like those developed by FlexFunds, which are created through a rigorous asset securitization process.
To learn more about ETPs and FlexFunds’ asset securitization services, feel free to contact our team of specialists. We’ll be glad to assist you!
Sources:
https://www.sec.gov/oiea/investor-alerts-bulletins/ib_structurednotes
https://www.jpmorgan.com/content/dam/jpm/wealth-management/documents/StructuredNotesBrochure.pdf
https://www.cnbc.com/2024/11/08/heres-why-etfs-often-have-lower-fees-than-mutual-funds.html
