Market Exposure with Principal Protection—A Powerful Duo
Participation in the market typically requires putting principal at risk, but not always.
Market Linked CDs (MLCDs), a type of structured investment, are designed to offer participation in the gains of the market with similar protective features of Certificates of Deposit (CDs)—including FDIC insurance and principal protection when held to maturity.
Why Consider Market Linked CDs?
Traditional CDs are generally considered safe and secure, with FDIC insurance, so holders are guaranteed to get at least a return of principal at maturity, up to the applicable FDIC limits. Traditional CDs typically offer an income stream of fixed coupon payments. MLCDs offer similar forms of capital protection, but instead of paying fixed coupons, they tie the payout of the investment to the returns of a market-based underlier. Investors gain the potential to generate more return on their investment if the underlier performs sufficiently well, although they also carry the risk of receiving no coupon payments at all if the underlier does not perform well.
How Do Market Linked CDs Work?
MLCDs come in two forms:
- growth-oriented, where market participation is the goal, and
- income-oriented, where income is the goal.
In both cases, the payoff is tied to the returns of an underlier. The underlier can be a single stock, a currency, a commodity, or an index.
For a growth-focused MLCD, if the underlier goes up, the investor will participate in its upside—at a pre-determined rate, and often up to a stated cap. Even if the underlier goes down, the principal is returned when the MLCD is held to maturity, backed by FDIC insurance.
Let’s take the following hypothetical MLCD as an example, and visually represent the return profile for better understanding:
- Market Participation: Instead of paying fixed coupons of a traditional CD, MLCDs offer payoffs that are linked to the returns of a market underlier. This gives the potential for higher returns, if the underlier performance—subject to any leverage or capped return—exceeds the amount offered by comparable products with fixed coupons.
- Capital Protection: Similar to traditional CDs, MLCDs offer a full return of principal when held to maturity, backed by FDIC insurance, offering Market Participation without downside exposure.
- Contingent Upside: Positive returns are not guaranteed. If the underlier loses value of the life of the investments, MLCDs will only return principal at maturity, while traditional CDs offer fixed coupons throughout the life of the products regardless of market performance.
- Liquidity and Statement Value: MLCDs are buy-and-hold investments, which means that investors must hold the note until maturity in order to receive the return of principal, and there is no guaranteed secondary market. Unless the MLCD offers interim coupon payments, investors must hold to maturity to receive a payment and participate in the gains of the underlier as well.
Who Should Consider Market Linked CDs?
Clients looking for higher return potential than the fixed yields offered by traditional CDs should consider the pros and cons of MLCDs.
Based on the level of risk an investor is comfortable with, MLCDs offer varying levels of participation. The payoff characteristics for MLCDs will depend on the term of the trade and the underlier. Let’s take two hypothetical MLCDs with different underliers—one linked to SPX for U.S. equities and another linked to SX5E for European equities—and illustrate their respective return profiles side by side:
Participation in the market typically requires putting principal at risk, but not always. If a client is looking for protective features offered by CDs, and still wants market exposure, consider taking a closer look at Market Linked CDs.
Are you a financial advisor? If your firm provides access to SIMON, you can view and filter for the latest Market Linked CDs available in SIMON’s 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.
You can also learn more about structured investments and how they can help keep clients invested over the long term with articles and videos available on simon.io/engage.