Market-linked investments are a type of structured product that provides exposure to financial markets while protecting against downside risk. These products have become popular among retail investors who want market exposure but with principal protection. However, market-linked investments also carry risks that investors should fully understand. This article will provide an overview of market-linked investments, their advantages and disadvantages, and things to consider before investing in them. We will refer frequently to the key terms market-linked investment and investment throughout.
Market-linked investments can provide upside potential with downside protection
A key advantage of market-linked investments is that they offer some downside protection or principal guarantee, meaning the investor will get back at least the original invested amount at maturity even if the linked market drops in value. These products also provide upside potential if the linked market increases in value. So investors can gain exposure to stock market growth while limiting full downside risk. However, the tradeoff is that potential gains may be capped at a maximum return. Market-linked investments use derivatives and structured notes to provide this asymmetric payout profile.
Various indices and assets can be used for linkage
Market-linked investments are not tied to just one market benchmark. They may derive returns from broad stock market indices like the S&P 500, sector-specific indices like biotech, or even alternative assets like real estate and commodities. Some market-linked investments allow switching among indices at certain times. This allows investors to shift exposure based on changing market conditions. However, returns are still dependent on the performance of the linked asset even with the downside cushion.
Liquidity and early redemption may be limited
A drawback of market-linked investments is that they tend to be less liquid than regular stocks and bonds. These products have set maturation terms, often 5-10 years, and there may be restrictions on early redemptions. Many market-linked investments are structured notes issued by financial institutions, which means liquidity depends on the issuer being willing to buy back the notes. There have been cases where investors in market-linked notes had difficulty getting full principal back when trying to redeem early.
Fees can erode total returns over time
As structured investment products, market-linked investments often come with higher fees compared to traditional securities. Typical fees include upfront commissions, management fees, and performance-based fees. These recurring fees are deducted from investment returns over the lifespan of the product. So even if the linked asset performs well, high fees can reduce the investor’s total gain. It’s important to pay attention to the fee structure when evaluating a market-linked investment.
In summary, market-linked investments can be useful for investors who want equity or commodity market exposure paired with downside risk management. However, they come with tradeoffs like capped gains, illiquidity, and higher fees. Assessing your risk tolerance and return objectives is key before investing in market-linked structured products.