Two Basic Types of Protection
As a reminder, both Soft and Hard Protection provide a level of downside investment protection against the underlying asset decline, the two are very different types of protections. While Advisors should also make their own conclusions on what type of protection is best suitable for their individual clients, there can be times when one type of protection looks more favorable than the other. Let’s explore…
Hard Protection
Hard Protection, the more conservative of the two, offers a “buffer” against market declines. The investor begins to incur losses once the protection level is breached. For example, take a 3 year Structured Note linked to the S&P 500 with 15% Hard Protection.
If at maturity, the S&P is down anywhere between 0% and 15% on a price-level basis, the investor would receive their full principal back. The Hard Protection level has not been breached since the S&P 500, in this example, didn’t decline more than 15%. However, if the S&P 500 was down 20% over the 3 year period this structured note investor would be down 5%. In short, it’s the difference between protection level and actual declines of the underlying index or asset.
Soft Protection
Conversely, Soft Protection acts like a “barrier,” meaning once the protection level is breached at maturity the investor is fully exposed to the price loss of the underlying asset. Again, let’s use the 3 year Structured Note linked to the S&P 500 as an example.
Instead of having 15% Hard Protection, let’s assume this Structured Note has 15% Soft Protection. If at maturity, the S&P 500 is down anywhere between 0% and 15% on a price level basis, the investor receives their principal back – just like with Hard Protection above.
However, if the S&P 500 is down 20% on a price basis at maturity, the investor is down the full 20%. This is similar to if the investor had invested in the S&P 500 outright, excluding dividends. This is a telling example of why Hard Protection is a more conservative type of protection versus Soft Protection.
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