How to Generate Alpha During a Low Growth Environment
Meet a structured investment designed to help outperform during low-to moderate-growth environments, while reducing downside market risk.
Right, wrong, or indifferent, a client weighs his or her portfolio's performance against the broader market. There are plenty of vehicles that perform well during a double-digit growth environment, but how do you consistently generate alpha during single-digit or negative market scenarios?
Market Linked Growth Notes, a type of structured investment, are designed to offer a unique approach to generating alpha for your clients during periods of low-to-moderate growth.
How do Market Linked Growth Notes work?
Market Linked Growth Notes can give investors an opportunity for leveraged exposure to the upside of the underlier, typically an index, ETF, or stock—up to a stated cap—with protection on the downside that comes in the form of either a buffer or barrier. In exchange, investors are exposed to the credit risk of the issuer and must be willing to hold their investment for a fixed term, to the maturity of the note.
Let's consider a hypothetical note with the following specifications:
*Volatility and credit spreads are two of several factors that affect the terms of any given note.
Over a two-year term, this hypothetical note provides upside participation of 2x the performance of the SPX index, up to a 20% max return. It also has a 10% hard buffer, which absorbs a fixed percentage of decline in the index. If SPX is down by 10% or less at maturity, the note holder gets their full principal back. However, if SPX is down by more than 10% at maturity, the note would be exposed to losses in excess of a 10% decline in the SPX, outperforming the index by 10%.
- Enhanced upside: MLGNs can deliver more than 1x participation in gains of the underlying index, up to a stated cap. The leverage generates outperformance during low-to-moderate growth environments.
- Downside protection: MLGNs can offer risk mitigation with an explicit downside hard buffer or a downside barrier. A hard buffer absorbs a fixed percentage of the index’s decline and, after that, losses are 1:1 with the market. On the other hand, a barrier absorbs a fixed percentage of the index’s initial decline; however, for a decline beyond that level the protection disappears entirely, and losses are 1:1 from the index’s initial level.
- Credit Risk: Structured investment holders are exposed to the credit risk of the issuer, and must be comfortable with the issuer’s creditworthiness throughout the life of the trade.
- Liquidity and Statement Value: Structured investments are buy and hold investments, which means that investors must hold the note until maturity in order to receive any investment returns or principal, and there is no guaranteed secondary market. Issuing firms or dealers may be willing to buy back a structured investment before maturity, but may do so at a discount to statement value and are under no legal obligation to provide liquidity.
- Price Return: Holders of a structured note do not receive any dividends paid by the underlier, while a direct holder of the underlier itself would be entitled to dividends.
How do Market Linked Growth Notes Perform?
Let’s look at 4 different market scenarios and outcomes for each with the hypothetical note.
Who Should Consider Market Linked Growth Notes?
A client with equity exposure as part of their asset allocation, who is willing to add credit risk to their portfolio and sacrifice some near-term liquidity, may want to consider allocating a portion of that exposure to Market Linked Growth Notes.
Let's say a client has a 60% portfolio allocation to equities, and within that allocation, they invest in mutual funds, ETFs, and stocks. By taking, say, a third of that equity allocation—or 20% of the entire portfolio—and reallocating it to Market Linked Growth Notes, their overall equity portfolio would have risk-management features to help -position for certain market conditions. In this reallocated portfolio, the 40% allocated to equities that remain invested in uncapped traditional investments would give the client full upside and downside exposure, outperforming Market Linked Growth Notes if the markets outperform the cap, while the 20% invested in Market Linked Growth Notes would outperform as depicted in the chart during down to moderately-up environments.
Are you a financial advisor? If your firm provides access to SIMON, you can view and filter the latest Market Linked Growth Notes available to you in the Marketplace on simonmarkets.com. If you do not have access to simonmarkets.com and would like to learn more, connect with our team by emailing us at firstname.lastname@example.org and request a demo with one of our Platform Specialists.
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