During the 2022 bear market, stocks and bonds had significant declines. With the bond index down 18% and the S&P down 26%, the traditional stock/bond hedge was broken. Coupled with a zero-interest rate environment, we looked at alternative investments to provide better diversification and income for our client portfolios. Structured income notes were added to the portfolio models to provide needed income and a buffer against market declines.

A structured note is a credit instrument of a large money center bank. We buy notes sponsored by Citigroup, JP Morgan, BMO and others. Like a CD, the note is for a defined period, usually 3 or 4 years. Monthly interest payments are made during the term and the purchase price is returned at maturity if the market indexes on the day of purchase have not declined by the more than the barrier level at maturity. Typically, we buy notes with a 35% to 40% barrier level which means that the stock market would have to decline by more than 35% over the three to four year term for the purchase price to not be fully returned. Notes do not have FDIC protection but are a credit obligation of the bank and are subject to their creditworthiness.

Rates of return vary based on market volatility. This year we have seen rates in the 8% to 10% range which is a better return than we have previously seen on bond funds. The monthly interest payments can be dollar cost averaged into retirement portfolios or can be used as a monthly income stream for retirees. Notes are also available in a 13-month version which can be a higher yielding alternative to bank CDs. Lastly, gains on these 13-month notes are taxed at capital gains rates which are lower than ordinary income rates.