Protecting Your Portfolio: Is it Time to Change Your Ways?

By: Dominick Paoloni, CIMA®

Managing money is extremely difficult and ever changing. According to AARP, the two greatest concerns of their members are outliving their income and not having enough savings to retire. During the last twelve years the capital markets have exacerbated this problem with volatile stock markets and crashing real estate values. Good money managers lost less, which gives little solace to the investors whose main concern is growing their nest eggs.

Where should investors turn? Bonds are trading at all-time highs due to low interest rates, which means the long term outlook on bonds is flat to negative. Stocks are substantially lower over the past decade and have remained unreliable since 2008. Real estate values have depreciated, and do not look like they are going to recover anytime soon. Annuities offer safety, but low interest rates and high fees have negated their value to clients, and similarly CD’s adjusted for taxes and inflation are losing about — 4% in a real rate of return. While we believe that IPS clients will continue to see great value in their managed money accounts over time, for the client that cannot handle the market volatility a great place to turn is structured notes.

Structured Notes

Structured notes are innovative investment solutions that allow for market participation while limiting or eliminating downside risk. Structured notes have been offered by insurance companies and banks for years, but high fees have reduced their values. IPS now provides additional value to our clients by creating flexible, low cost, transparent, and customizable notes to suit the client’s needs.  Structured notes are the answer for the person who fears being “in the market”, but recognizes the lost opportunity of being “out of the market”.

Structured notes can be designed around almost any asset class including, but not limited to, the S&P 500, gold, emerging markets, and currencies. Not only do structured notes allow the investor to participate in the positive returns of an asset, with limited exposure to the downside, but when IPS designs a structure the primary risk lies in the longevity of the organization backing the structure. For example, if we build a two year structured note for a client backed by a US Treasury bond, the client’s note will maintain its value as long as the US government does not default during the two year holding period. This means that with an IPS structured note, we can give our client’s the benefit of being invested in an asset while limiting the risk to that of a US Treasury.  On the other hand, we could use the bonds of Exxon Mobil or Bank of America to back a note. In exchange for the higher probability of default, the client receives a higher level of upside participation.

Giving to Get

The question I always get when I talk to clients about structured notes is, “What am I giving up to participate in the market without downside?” After all, there is always two sides to investing; the benefit you receive as an investor, and the risk you take. Liquidity is the primary restriction with structured notes. If you buy a two year structured note, your money is tied up for that period of time. The structured note may not provide protection against market losses if not held to maturity.  Because we know the importance of liquidity over a long period of time, we offer customizable holding periods usually between one and three years. We also emphasize a laddering approach to structured notes, just as one might ladder bonds. This increases the likelihood that you will get in at opportune times, and also ensures that you will have access to a portion of your funds on a regular basis.

Diversify to Increase Growth Potential, not to Reduce Risk

Money managers diversify among asset classes to control or dampen risk. Assets such as gold, which typically move in the opposite direction as the markets, are held to reduce losses in the account when the stock market goes down. This counterbalance strategy won Dr. Markowitz the Nobel Prize in 1990 and has been the basis of portfolio design for the last 50 years. With structured notes we can stay 100% invested in an asset class without fear of losses. For example, if we build a two year protective note with gold, the fluctuation in gold prices ceases to be a concern in terms of losses. If gold is higher at the end of two years the client benefits from participating in the rise, and if gold is lower the client gets a return of principal. Below are two examples of structured notes that IPS can build for clients.

IPS Structure Brochure.pub

 

 


IPS Structure Brochure.pub

 

A Hands-On Approach to Downside Protection

You will notice that the logo of IPS Strategic Capital is a bear. This is because our goal is to protect your portfolio from the bear markets so you can enjoy the gains of a bull market. Over the years our managed money portfolios have outperformed the markets on the downside, but cannot completely eliminate market losses. Structured notes provide yet another investment option for our clients, and is also a great option for pensions and endowments whose missions depend on protecting and growing their accounts.  Contact us to find out if structured notes can help you meet your financial goals.

*Please note the this is for informational purposes only and is not a recommendation to buy or sell any securities. Please consult IPS or another financial professional before making any investment decisions.