A Structured Note as a Hedge for Value Investors
Structured notes can be an excellent way for value investors to mitigate risks associated with volatile stocks. Here’s an example using Apple stock:
Back in December 2012, Apple’s stock price dropped from $705 to the low $500s, prompting concerns about its profitability and competition, notably Samsung’s new 5” Galaxy S4. I utilized a screening method to identify stocks that had dropped by at least 20% over six months, which is how Apple caught my attention.
I believed Apple wouldn’t ignore the market’s demand for a larger screen iPhone and anticipated they would start returning more cash to shareholders given their substantial cash reserves. At the time, Apple’s earnings multiple was attractively lower than the S&P 500’s, suggesting a favorable risk-reward ratio in the low $500s.
Hedging the Investment
Despite the potential, directly investing in a declining stock seemed too risky—akin to “catching a falling knife.” Instead, I turned to structured notes as a safer investment alternative, specifically, Equity-Linked Notes (ELNs).
The Structured Note Trade-Off
I chose a structured note that provided a 20% downside protection and a guaranteed 3.5% return over six months, provided Apple’s stock did not fall below this threshold. This seemed a safe bet as Apple was trading at $520, and the prospect of it dropping below $415 by June 2013 appeared unlikely.
Despite this safety net, Apple’s stock did indeed fall below $400 in April 2013. This significant drop meant that if Apple’s stock price was below $415 by the maturity date, I would lose a proportional amount of the principal invested—a stark reality check about the risks involved, even with structured notes.
Had I invested directly in Apple shares at $520, the situation could have been more stressful, possibly leading me to sell at a loss or desperately hold on for a rebound.
Reflections on Structured Notes
Structured notes can provide some cushion during downturns, but they are not without risks. They do, however, offer a way to participate in potential upsides while limiting downside exposure—essential during volatile market conditions.
Reinvestment Strategies
After my structured notes matured in 2021, I was left with a substantial sum to reinvest. With high market valuations, I considered alternative investments, such as real estate, to potentially extend my gains while reducing volatility.
Diversifying Investments
I also advocate for diversifying into private growth sectors through vehicles like the Innovation Fund, which focuses on sectors such as AI and FinTech. These investments offer a chance to engage with emerging technologies before they hit public markets, potentially leading to significant returns.
Managing Finances Efficiently
Using tools like Empower to aggregate and manage financial accounts can significantly simplify financial oversight and planning. Such tools allow investors to track investments, analyze fees, and plan for retirement—all from a single platform.
In conclusion, while structured notes can be an effective investment tool for managing risks, they require careful consideration of the terms and the specific market conditions. Diversifying investments and keeping a keen eye on financial management practices can also enhance investment outcomes and financial stability.
