How you can pursue more tailored returns your way

Many of our clients experience investing as a binary activity—in the market or out; risk on or risk off. While this might feel easy for clients to grasp, over time, this mindset can lead to an overly simplistic, or overly defensive, investment strategy.

While that might feel secure in the moment, it may not prove to be the best long-term decision. The truth is that no matter your position or your concerns, you have a lot of options in between all-in and all-out.

Structured products can help clients who are looking for a way to allocate that feels right because it’s more nuanced, and still has the potential to meet their investment goals. With these hybrid products, you can create more defined payouts for a portion of your portfolio while diversifying your investments. Structured products complement traditional assets like equities and fixed income but are not correlated to either. We see them as a “third leg” in the portfolio stool.

Structured products pair a fixed income instrument with an over-the-derivative , and they allow you to take a middle path: You can customize your exposure to a degree that works for you—by trading some potential upside in return for downside protection. This can let you seek an asymmetric payoff, which is an opportunity where the reward can be greater than the risk.

While structured products aren’t new, there have been notable innovations in their use. We’re now able to trade them more swiftly, which makes it easier to create customized structures for clients. They’re now seen as tools that can be used in a wider variety of ways. We’ll discuss three of those uses here: As a way to diversify a portion of cash holdings, for income and for hedging.

Diversifying a portion of your cash

We have clients with outsized allocations to cash because they’re concerned about a costly downturn or a vulnerability. In general, we define cash allocations of 20% or more as excessive.

However, allocating excessively to cash can put these clients at risk for return shortfalls while inflation steadily erodes the cash’s value. It’s also an approach that is ill-timed during a cycle of interest rate cuts.

Historic data shows that shifting part of these allocations out of cash and into structured products may provide opportunities for enhanced returns without a significant increase in risk. Such a shift would also keep investors aligned with their goals and their needs.

For example, our research shows that in a portfolio with a balanced equities-fixed income allocation¹, replacing a 20% allocation to cash with structured products has the potential to increase the annual return with only a modest increase in overall average volatility.

Income investors

Clients who make fixed income the bedrock of their portfolios are often looking for steady, dependable yields to help maintain their lifestyles. We’ve found that including structured products in a portfolio may help maintain income and has the potential to enhance yield.

These products often include features that can offer higher yields compared to traditional fixed income securities while still providing a level of principal protection. Structured notes can be tailored to meet specific income needs, offering a balance between risk and reward that aligns with the investor's lifestyle and financial objectives.

Our research shows that in a portfolio with a balanced equities-fixed income allocation² with a 20% additional bond allocation, replacing the additional bond component with a basic S&P 500 structured investment product³ would have the potential to increase the annual return while overall average annual volatility was unchanged. Although structured products may enhance yield, they also introduce additional risks investors should consider.

While structured products may enhance yield, it is important to note that structured products introduce additional risks investors should consider. They may carry a higher degree of some risk factors, including the potential for unlimited loss and increased volatility in certain transactions.

Downside hedging

Clients who are highly attuned to risk and focused on capital preservation—who are concerned about equity prices and waiting for a better entry point, for example—may be likely to stick to familiar and traditional portfolio construction. For them, structured products have the potential to enhance returns even as they potentially reduce volatility by adding a downside buffer that reduces potential losses.

Returning to the example of a client with a traditional balanced stock-bond allocation,⁴ our research shows that adjusting the portfolio so it is 80% traditional with 20% structured S&P 500 investments⁵ would have the potential to increase annual returns while actually reducing average volatility. While structured products can offer downside buffers, they are also subject to risks investors should consider.

Structured notes can include downside protection features that help mitigate losses during market downturns (though, again, investors should consider the risks these securities are subject to). By integrating structured notes, investors can diversify their risk exposure and potentially enhance returns while maintaining a defensive investment strategy.

This is especially relevant as markets move into a new phase: We think stock-bond correlations could increase due to higher inflation and high equity market concentration—meaning that stock and bond returns are more likely to move in the same direction. This is one reason we think it’s important to diversify beyond stocks and fixed income. We think holding structured products and nontraditional asset classes is particularly important.

Conclusion

Finding the right way to fund a structured products allocation is also a question with an individualized answer. Factors in identifying the right path for you will include your needs, investment objectives, time horizon and existing allocation to these assets (if any).

Regardless of the particulars, it’s our conviction that structured products have the potential to add diversification and risk management to investors’ portfolios. While every situation is different, some investors may want to consider a phased approach that allocates up to 15% to 20% of investable assets to structured products.

In an investing environment shaped by rising rates and concerns about elevated valuations and equity concentration, we advise using structured products to diversify your holdings while adding income. This approach can help you manage risk while meeting your needs for the long run.

We can help

To learn more about whether structured products may be appropriate for your portfolio, how they might be integrated into your investments, and how they can potentially help you achieve your goals, contact your J.P. Morgan team.