The value of yield notes – driving return (part 1)
As we touched on in our January 24 portfolio update, we are allocating to structured yield notes with favorable terms to drive strong risk adjusted returns for investors with a built-in level of downside protection.
Our investment team seeks yield notes with attractive risk/reward profiles. As part of a diversified portfolio and in an uncertain environment, yield notes can be a solid investment alternative outside of traditional stocks and bonds.
Yield notes are customizable, and we tailor them to achieve the specific investment objectives of each of our investors. In today’s uncertain environment, yield notes can add a lot of value to a portfolio.
The structured yield note that we mentioned on Tuesday in our January 24 portfolio update generates a 9.3% annual return (so long as certain conditions hold true). Today we want to demonstrate how yield notes work as a reminder to investors, using this yield note as an example.
Key terms of the note:
Term: 18 months
Issuer: Morgan Stanley
Underlying asset: Russell 2000, Nasdaq, S&P500
Yield: 9.3%
Principal protection: 40%
Coupon protection: 40%
Coupon payments: Monthly
Callability: Issuer call, quarterly
Issue date: January 23 2023
Final valuation date: July 15 2024
The note explained in basic terms: Investors receive a 9.3% annual return plus principal so long as the worst performing underlying asset (Nasdaq, S&P500, Russell 2000) is not down by more than 40% between the issue date of the note and the final valuation date. Yield notes are ranked as senior unsecured debt, behind only senior secured debt and deposits in the capital structure.
Coupons are paid monthly (so long as the worst performing underlying asset is not down by more than 40% from issue date on each monthly coupon observation date). The issuer (Morgan Stanley) has the right to call the note away every quarter if all of the underlying indices are up. When an issuer calls a note away, we reassess the investment universe and either allocate the capital into a new yield note, or a new opportunity with a stronger risk/reward profile (like stocks).
For those interested in the mechanics of this yield note, we second article that goes through the terms in detail. Part 2 also explains our reinvestment strategy if we were to see a breach of principal protection on a yield note. At GoalVest, we build yield notes with what we consider to be low probabilities of loss, and to date we have never seen a breach of principal (though that’s not to say it can’t happen).
Yield notes don’t just work in up markets, they can work in down markets too (so long as levels of protection aren’t breached). For example, over the one-year period between March 2019 and the covid lows of 2020, the S&P500, Nasdaq and Russell 2000 all saw negative returns. Investors in the S&P500 received a return of -18.92%. However, each index was down by less than 40%. This means that an investor that owned a yield note with 40% principal protection on those assets would have received full principal and a positive return despite extreme market volatility. This demonstrates the role that yield notes can play in achieving strong risk adjusted returns (including in challenging environments where stocks and bonds are down).
The mechanics of yield notes are explained further in our 'part 2' article.
Disclaimer
The information presented should not be considered personalized investment, financial, legal, or tax advice. This notification is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein. Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, and are based primarily on assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change. Past performance is not indicative of future performance. Principal value and investment return will fluctuate. There are no implied guarantees or assurances that the target returns will be achieved, or objectives will be met. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal. The values and performance numbers represented in this report reflect management fees. The values used in this report were obtained from sources believed to be reliable. Performance numbers were calculated by Black Diamond using the data provided by your custodian. Please consult your custodial statements for an official record of value.
The securities involve risks not associated with an investment in ordinary debt securities. Selected Risks Associated with any of these structures include: - Notes are not principal protected and investors can lose some or all their initial principal if the underlying asset falls below the Principal Barrier Level. - Contingent coupon payments. Investors may not receive periodic interest payments if the performance of the underlying asset falls below the Coupon Barrier Level. It is possible that investors will not receive any coupon payments over the life of the Note. - Potential for early redemption and reinvestment risk. Notes will be automatically called if the performance of the underlying asset is at or above the Initial Strike Price on the defined Observation Date. If called, investors may not be able to reinvest their proceeds in a product with a comparable coupon. - Returns are limited to the coupon payments, if any. Investors will not participate in any price appreciation of the underlying asset. Additionally, investors will not receive dividend payments generated by the underlying asset. - Limited secondary market. Notes should be considered buy-and-hold investments and investors should hold them to maturity. They are not traded on an exchange and there may be little to no secondary market available. - Issuer credit risk. Notes are senior, unsecured debt obligations of the issuer and all payments of income and principal are therefore subject to the creditworthiness of the issuer. - Complex investments. Notes may have complex features and may not be suitable for all investors.