Unit Trusts vs Structured Notes

When it comes to building wealth, one of the most common investment vehicles promoted are unit trusts. As one of the most traditional forms of investments, unit trust is essentially a pool of money that buys into a fixed portfolio of assets that a specific fund selects. This portfolio is usually made up of numerous assets within a region or industry that are selected according to the fund’s investment objective, strategy, and assessment of the market.

Unit Trust in a nutshell

As mentioned, a unit trust spreads a sum of money across multiple securities such as stocks and bonds to create a diversified portfolio. The basic idea is simply purchasing a piece of this portfolio that has been constructed by fund managers, thus removing the hassle of deciding what securities to purchase on your own.

Funds are managed by professional fund managers and analysts with experience in the field of investments. It is with their knowledge and analysis that individual securities are selected and assembled into a portfolio. However, what if you don’t agree with what they choose?

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Taking a closer look

While providing some form of diversification through its wide range of asset choices, one thing that investors must deal with are the additional fees that funds charge regardless of their performance.  If the fund profits 7%, investors will only receive a net 5% back after going through management fees and transaction cost. Likewise, if the fund booked a -2% loss in a year, fees and transactions would have led to investors totalling further losses (-4%).

As investment decisions are made by fund manager’s discretion, investors lack any control over individual holdings in the portfolio and are to rely solely on the expertise of these managers to make decisions hoping that they will deliver results at the end of the day.

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Why choose Structured Notes?

With structured notes, however, investors are given greater freedom in deciding the composition of assets they want to peg their performance to. Among many other features, the main ones are; selecting the number of assets, the type of asset, the duration of the commitment, frequency of coupon payments, and the level of protection barriers to have in place.

For example;

Underlying Index S&P 500, Nikkei 225
Coupon X%
Frequency Semi-Annual
Duration 6 Years
Coupon Trigger 70%
Protection Barrier 60%

This simple example shows a structured note consisting of 2 underlying indices that issues a fixed semi-annual coupon payment of X% every year for 6 years as long as both indexes do not drop below 70% of its initial price during observation date.

The capital is also protected so long as none of the underlying falls below the protection barrier; 60% of initial price at maturity date. This means that if the structured note was executed on 1st Jan 2006 with S&P priced at 2,000, as long as S&P is above 1,200 (60% x 2000) by maturity at 2016, full capital is returned to investors; Likewise, for the Nikkei 225.

Depending on the individual’s preference, structured notes can be built in a way to achieve specific investment objectives; income generation, capital preservation, capital appreciation, etc. With this flexibility to carefully hand pick assets they deem desirable and exclude unwanted ones, it is no wonder why investors are increasingly adding structured notes into their investment portfolio.

Furthermore, the attractiveness of structured products as an investment vehicle is further enhanced with its upfront cost and 100% asset allocation without any hidden management fees. After all, investment products should be transparent, flexible, and tailored to different investment objectives and built in such a way to adequately fit with a holistic portfolio.

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