Structured Notes in South Africa: What the Brochure Doesn’t Tell You

What Are Structured Notes?

Think of a structured note as a wrapper that blends stability with potential growth. A bank builds it from two parts: a bond or deposit that grows back to your original investment at maturity (the protective backbone), and a derivative contract, usually options, that links your return to a chosen market such as the JSE Top 40, the S&P 500, a currency, or a commodity.

In plain terms, you’re lending money to a bank. In return, it promises to give you back your capital at the end of the term (if protection applies) plus a payoff determined by how the market behaved over the period.

Local vs Offshore Structured Notes

South Africans can access structured notes both locally and offshore, and the distinction matters for currency, tax, and estate planning.

In practice, many higher-net-worth investors use both: local notes for rand stability and offshore notes for diversification.

The Main Types of Structured Notes

Structured notes come in many flavours, but most South Africans will encounter four main types. The key differences are how much capital protection you get and what you give up in exchange.

How Structured Notes Work

Most notes follow a familiar recipe: roughly 80–90% of your money goes into a bond or deposit to protect capital, and the remaining 10–20% buys the options that create the payoff. At maturity, you get your capital back (if protection applies) plus whatever the derivative delivered.

There’s a trade-off that’s easy to miss: you usually don’t receive dividends. In South Africa, where dividends make up a large share of total equity returns, giving them up is a meaningful concession over a five-year term.

A structured note also doesn’t buy the index directly. The bank isn’t purchasing the JSE Top 40 or S&P 500 for you — it uses derivatives engineered to track performance according to set rules. Because you don’t own the underlying assets, you receive no dividends, you have no voting rights, and your payoff depends on the bank honouring the contract. You’re exposed to both the market’s behaviour and the issuer’s credit risk.

Worked Example: How the Options Create the Payoff

Here’s how one real-world five-year note was actually built, from each rand invested:

With 19% available, the bank buys at-the-money call options (costing 17.8%) and sells call options 40% above the index (earning 3.5%), for a net option cost of 14.3%. That 19% budget against a 14.3% cost funds roughly 1.33 times exposure.

The result: you receive about 133% of market growth, but only up to the first 40% rise in the index. If the index rises 20%, you earn around 26.6%. If it rises 40% or more, you’re capped at 53% (40% × 1.33). If it falls, you still get your capital back, assuming no credit event. Most of your money buys back your own capital, a slice pays fees, and the rest is engineered into geared-but-capped upside.

How They’ve Actually Performed

Because so much capital is reserved for protection and fees, structured-note results look very different from straightforward share investing.

Capital Protected Note vs JSE Top 40

On R1 million invested for five years:

The takeaway: peace of mind, but at the cost of dividends and capped upside.

Autocall in Sideways Markets

In 2019, a note tied to the S&P 500 and FTSE 100 promised 12% annually if both indices stayed above 60% of their starting levels. During the COVID crash, markets plunged and the barriers were threatened. By 2022 markets had recovered and the note auto-called, paying investors 36% over three years in USD. Strong returns in an otherwise stagnant market — though it would have lagged badly in a sustained bull run.

The Risks That Matter

Structured notes can feel safe. History tells a more complicated story. When you evaluate a note, peel back the layers in order: issuer credit risk, capital protection terms, the underlying index, the payoff rules (caps, barriers, participation), liquidity, currency, dividend treatment, embedded fees, and tax.

The risks that have actually hurt investors tend to be these:

• Issuer credit risk. The collapse of Lehman Brothers in 2008 left holders of Lehman-issued notes with near-total losses, regardless of how the linked markets performed.
• Barrier breaches. In the March 2020 crash, steep drops triggered barrier breaches in many autocall notes globally. Investors expecting steady 8–12% coupons suddenly faced equity-like drawdowns. It’s reasonable to conclude several local autocall notes were similarly affected — a reminder that “protection” can fall away exactly when markets collapse.
• Liquidity traps. Notes are designed to be held to maturity. South African secondary markets are thin — often only the issuing bank will buy back, and usually at a discount of 10–20%.
• Complex payoffs. A digital note might pay 10% if the index stays above 90% of its start value but nothing if it slips to 89%. A tiny move can mean a total loss of coupon.

The harsh reality is that structured notes tend to disappoint during market stress — precisely when investors expect them to protect. Capital protection is conditional. Always test the scenarios where barriers are breached.

Credit Risk and the Bank Capital Structure

When you buy a structured note, you’re exposed not only to market performance but to the creditworthiness of the issuer. The repayment promise is only as good as the balance sheet behind it. Where a note sits in the bank’s capital structure determines how much of that risk you carry.

Some notes go a step further and link repayment to external reference entities, through what are called credit-linked notes. One CLN in the local market was linked to the subordinated Tier 2 debt of three global banks — Barclays, Standard Chartered and NatWest — with equal 33.3% exposure to each. If any one of them suffered a credit event (bankruptcy, failure to pay, restructuring, government intervention), the issuer was no longer obliged to repay full capital. In other words, even if the S&P 500 exposure performed well, an unrelated default at one reference bank could trigger a capital loss.

The key point: standard senior-unsecured notes carry moderate credit risk; CLNs linked to Tier 2 debt carry much more, because they sit further down the repayment waterfall. “Capital protection” only holds if the issuer and any reference entities stay solvent and your claim ranks high enough.

Fees and Transparency

Unlike a unit trust with a published TER, structured-note fees are hidden in the design. The bank keeps its margin by adjusting the participation rate or coupon rather than charging a visible fee.

Consider two banks issuing the same five-year JSE Top 40 capital-protected note. One offers 60% upside participation, the other 50%. That 10% gap is, in effect, the second bank’s margin. As a rule of thumb, where two otherwise similar notes offer different participation rates, the one with the lower rate usually carries higher embedded costs.

Three questions cut through the opacity:

• What is the implied participation rate versus market norms?
• How much of the dividend yield is being retained to fund costs?
• Are there separate placement or distribution fees?

Tax and Estate Considerations

Tax treatment depends on the note and the jurisdiction, and it can materially change the outcome. Always compare after-tax returns, not headline coupons.

This is where structuring earns its keep. Wrappers and trusts can address three problems at once — estate taxes, reporting, and liquidity. Local endowments are taxed at 30% with direct beneficiary nomination; family or discretionary trusts are useful for intergenerational planning but face tighter tax rules; and offshore investment wrappers are often essential for offshore notes, neutralising situs tax, simplifying SARS reporting, and allowing switches without triggering tax. For offshore notes in particular, a wrapper is frequently the difference between an elegant solution and a tax-heavy estate headache. The broader estate angle is covered in our guide to estate planning in South Africa.

When Structured Notes Make Sense

A structured note should be a sleeve within a portfolio, not the whole thing. The market environment largely determines whether it will reward you.

In strong bull markets, low-cost ETFs usually outperform, because they capture full upside and dividends. And at maturity, providers often suggest rolling into a new note — which can make sense if volatility is high and your horizon still fits, but it should never be automatic. Reassess your needs each time rather than locking funds away by default.