CIO tutorial: What are structured solutions?

Despite their often ambiguous titles—such as reversible barriers or capital-protected banknotes—structured solutions are usually built to serve relatively simple goals. These goals can include providing a safety net to reduce potential losses or to add additional revenue. They can also enable the investor to express more complex views regarding the outlook for a particular market – such as looking to profit when the markets are trading in a narrow range.

As with the more exotic dish, structured products are usually made from a variety of ingredients — including stocks, bonds, and derivatives. This can allow investors to take positions or reduce risk in any of the major markets. But while they can make an attractive side dish, they won’t usually be the core of a wallet. In fact, they usually make up a relatively small part of a broad wealth strategy. Structured products are also generally more complex than standard stocks and bonds, and they carry specific risks that investors must be aware of and able to manage.

What are structured solutions?

At the most basic level, structured solutions are tools created by mixing different assets and derivatives together to achieve a specific goal. Essentially, they can enable investors to customize – or “adapt” – their exposure to a particular asset class – including adding downside protection or maximizing potential upside. Once they do their job, or fail to do so, they usually expire – usually from two months to a few years in duration. This makes it very different from, for example, holding large stocks, which may remain in a portfolio as a long-term position. However, this does not mean that portfolios cannot be dedicated to long-term structured solutions, but much more that strategies within this group may change over time.

Therefore structured solutions are commonly used in tactical positioning to take advantage of changing market conditions. Because they are highly customizable, they can be designed to meet very specific needs and goals across a range of markets, including stocks, bonds, currencies, and commodities.

Because of their diversity, structured solutions can be best understood by analogy – either as adding interesting ingredients to a basic dish or just as a toolkit to help an investor achieve certain goals. They can also vary greatly in terms of the risk/reward they offer – from the full protection of the principal amount, to the structures that put the full amount of investment capital at risk.

In what way can they add value to portfolios?

Financial experts often point out that structured solutions have complex rewards – meaning that their potential returns or losses can be unlocked if the price of the underlying asset crosses a certain threshold. But while the scope of the results can be complex—a major risk we’ll address later—the goal of structured solutions is to perform many of the possible functions.

Reduce risk: Some structured products are designed to ensure a certain degree of capital protection – to limit the maximum drawdown on a particular asset, such as individual stocks or a stock index. This can be an attractive alternative in times of unusual uncertainty in financial markets – when forecasting the economic outlook becomes particularly difficult, including times of geopolitical conflict. In times like these, a structured solution can provide investors with a degree of security, without exiting the market entirely – since timing markets are often difficult and expensive, ultimately sacrificing long-term returns.

Adding additional income to portfolios: At the time of writing in 2022, bond yields are rising in most parts of the world. While this has made it easier to add income to portfolios, most fixed income products come with long-term risks, which in an environment of high prices often leads to a loss of capital. Structured products can also offer a yield, but unlike the interest payments made by a bond issuer, they derive their income by taking advantage of the movement in the prices of an underlying asset such as stocks, commodities or currencies. This alternative source of return, regardless of the bond, can diversify the drivers and amount of portfolio income and return. The income on offer may exceed that of traditional government bonds, but it comes with additional risks.

Benefit from specific market outcomes: Expressing an opinion about the direction of the financial markets is often very simple. An investor who expects the stock market to rise can simply add to his or her holdings of the index. If an investor expects the market to drop, he can reduce exposure, put him in more defensive sectors, or hedge against a drop by using put options, for example. On the other hand, structured products can enable investors to look for a return in less obvious directional or binary situations. A structured solution, using a hypothetical example, can allow an investor to profit if a stock index trades in a 10% range up or down over the next year. These customized solutions can help investors who have more accurate opinions on how the market is developing.

Access to specific rewards: Some structures can offer investors the opportunity to obtain unique, difficult, or impossible strategies. For example, exposure to the movement of one or more underlying assets, such as multiple indices on the same time frame or a specific basket of stocks.

Structured solutions can be an important part of an investor’s toolkit, which can help fine-tune the traditional buy-and-hold strategy. They are usually used tactically, to address various goals – such as reducing the potential for a downturn in volatile markets, adding a return beyond standard fixed income alternatives, or seeking to gain from specific market outcomes beyond just bullish or bearish markets. However, achieving greater certainty about results is not without cost. In exchange for increased certainty, investors must be willing to accept a lower expected return, forgo investment income, or sacrifice liquidity when compared to a traditional execution approach.

Main contributors: Christopher Swan, Moritz Vontobel, Luca Henzen

See the full report – CIO Tutorial: What are Structured Solutions? , September 16, 2022.