Key takeaways:
- Structured notes are similar to bonds but with a different return structure.
- Its returns depend on the performance of a specific underlying performance (for example, the S&P 500 Index).
- You typically have to agree to hold the structured note until its maturity date.
- Your principal for some notes can be protected.
- Structured notes can provide higher returns than traditional bonds with less risk than equities.
When markets are volatile or interest rates are uncertain, many investors look for ways to earn returns while managing risk. One investment option that often comes to the fore in these situations is structured notes.
While the name might sound complex, the idea behind structured notes is fairly straightforward: they’re investments designed to deliver returns based on how one or more underlying assets perform (such as stock market indices, baskets of stocks or interest rates).
What is a structured note?
A structured note is a debt investment issued by a financial institution, typically a Canadian bank. Unlike with traditional bonds, the return on a structured note is not fixed. Instead, it is “structured”, meaning its returns depend on the performance of a specific underlying investment.
Think of a structured note as a custom-built investment that combines two components:
- A bond component, which helps return your principal at maturity (in some structures).
- A derivative component, which links your return to the performance of something else, such as the S&P/TSX Composite Index, the S&P 500 or a basket of Canadian dividend stocks.
Together, these components create an investment with a defined outcome, explained upfront before you invest.
How do structured notes work?
When you invest in a structured note, you agree to hold your investment until a set maturity date, often between three and seven years. During that time, your return depends on how the underlying investment performs, subject to specific rules.
Here are the key features most structured notes include:
Principal protection (full or partial)
Some structured notes offer principal protection, meaning that if you hold the note until maturity, you receive 100% of your original investment back, regardless of how markets perform.
Other notes offer partial protection, for example protecting the first 10% or 20% of losses. In exchange for taking on some downside risk, these notes typically offer higher potential returns.
Returns linked to market performance
Instead of earning interest like a bond, your return may be linked to:
- A stock market index (for example, the S&P/TSX or S&P 500).
- A basket of Canadian or global stocks.
- Interest rates or other financial benchmarks.
The return is calculated using a formula explained in the investment’s terms, such as a participation rate (which determines the percentage of the appreciation or depreciation the investor receives) or a capped return (which is the maximum potential return, no matter how well the investment performs).
Defined outcomes
Unlike traditional investments, where outcomes are uncertain, structured notes are designed with known rules:
- How returns are calculated.
- Whether returns are capped.
- What happens if markets fall.
This clarity is a key appeal for many investors.
Example of how a structured note works
Let’s look at an example* of a five-year structured note linked to the S&P/TSX Composite Index with the following features:
- 100% principal protection at maturity.
- Participation rate of 80%.
- Maximum return of 40% over five years.
What does this mean in practice?
- If the index rises 30%, you earn 24% (80% of 30%).
- If the index rises by more than 50%, your return is capped at 40%.
- If the index falls, you still receive your original investment back at maturity.
This structure can appeal to investors who want market exposure but are uncomfortable with the full downside risk of investing directly in equities.
Why do Canadian investors use structured notes?
Structured notes are not designed to replace traditional investments like stocks, bonds or mutual funds. Instead, they’re often used to complement a diversified portfolio.
Some potential benefits include:
Risk management
For investors who are cautious about market volatility, structured notes can offer a way to stay invested while limiting downside risk.
Customization
Structured notes can be designed for different objectives:
- Growth-focused notes linked to equities.
- Income-focused notes that provide periodic payments.
- Defensive notes aimed at capital preservation.
Tax efficiency (in some cases)
Returns from structured notes are often taxed as capital gains rather than interest, which may be more tax-efficient for non-registered accounts. (Tax treatment depends on the specific structure and individual circumstances.)
Important considerations and risks
While structured notes offer flexibility, they’re not suitable for everyone. Canadian investors should understand the following considerations:
Issuer risk: structured notes are obligations of the issuing bank. If the issuer were to default, your investment could be at risk, even with principal protection.
Liquidity: most structured notes are designed to be held until maturity. While early redemption may be possible, it can result in losses if markets have moved unfavourably.
Capped upside: in exchange for protection, many notes limit how much you can earn. If markets perform exceptionally well, a direct investment may outperform a structured note.
Complexity: while outcomes are defined, the mechanics can be complex. This is why working with a financial advisor is important.
How structured notes fit into a portfolio
Structured notes are often used to:
- Reduce overall portfolio volatility.
- Add exposure to markets in a controlled way.
- Bridge the gap between conservative and growth investments.
They are particularly common among retirees and pre-retirees, and investors who want growth potential without taking on full equity risk.
Are structured notes right for you?
Because structured notes vary widely in design, professional advice is critical. Your IG Advisor can help:
- Assess whether a note aligns with your risk tolerance.
- Explain the return mechanics in plain language.
- Ensure it fits within your broader financial plan.
Structured notes are tools, and like any tool, their value depends on how and when they’re used. They can offer you a middle ground between safety and growth. By combining market-linked returns with defined risk parameters, they provide flexibility that traditional investments may not.
They are not a one-size-fits-all solution, but when used thoughtfully and with professional guidance, structured notes can play a meaningful role in a well-diversified investment portfolio. Ask your IG Advisor if structured notes will complement your investment portfolio. If you don’t have an IG Advisor, you can find one here.
* For illustrative purposes only.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Advisor.
Trademarks, including IG Wealth Management and IG Private Wealth Management, are owned by IGM Financial Inc. and licensed to subsidiary corporations.
Mutual funds and investment products and services are offered through the Mutual Fund Division of IG Wealth Management Inc. (in Quebec, a firm in financial planning). Additional investment products and brokerage services are offered through the Investment Dealer, IG Wealth Management Inc. (in Quebec, a firm in financial planning), a member of the Canadian Investor Protection Fund.
