Using structures to stay invested in stocks while limiting risk of loss

Video:The AI sell-off and US midterms: Live at the UBS Disruptive Tech Summit (6 mins)
CIO Live Replay: CIO Asia equity strategists on the AI sell-off and opportunities (30 mins)
Circle One Jumpstart: What next for tech volatility, quality bonds, and oil prices? (4 mins)

Asian stocks started the week on a stronger footing as concerns over artificial intelligence investment and Middle East risks eased. The MSCI Asia-Pacific index excluding Japan rose 2%, Japan’s Nikkei 225 gained 3.5%, and Taiwan’s benchmark rallied more than 6%. The moves followed Friday’s recovery on Wall Street and a decline in oil prices as prospects for progress in US-Iran negotiations improved.

The rebound should be viewed in the context of last week’s declines. Selling was centered on semiconductors and other AI-linked companies as investors reassessed the profitability of infrastructure investment, the funding of data center expansion, and the potential for greater regulatory scrutiny following the US midterm elections.

We believe the recent technology sell-off represents a positioning reset rather than the start of a structural downturn in the AI investment cycle. But the rebound does not remove the risks created by concentrated positioning and elevated expectations. Investors whose technology exposure has grown beyond its intended portfolio weight may therefore wish to use periods of market strength to rebalance, lock in some gains, and diversify across sectors and regions.

But certain types of structured strategies, sometimes known as capital preservation strategies, may provide a middle path for those who believe stocks can rise further but want greater peace of mind against an adverse outcome.

They combine potential loss limitation with participation in potential equity gains. Such approaches typically combine a zero-coupon bond with call options on an equity index or another underlying asset. The bond component is designed to return the predefined investment amount at maturity, subject to the issuer meeting its obligations, while the options provide participation in potential market gains. This can help investors retain equity exposure without assuming the full potential losses of a direct investment.

They can be tailored to an investor’s objectives and risk tolerance. The maturity, level of capital preservation, underlying asset, and participation rate can be adjusted. Investors may therefore replace part of a concentrated or linear equity position with a structure that more closely matches their tolerance for losses, investment horizon, and future spending needs. A blend of notes with different maturities and underlying assets can also help balance capital preservation and growth.

Predefined outcomes may make it easier to remain invested through volatility. Sharp market swings can encourage investors to sell after prices have fallen or remain in cash while waiting for a more attractive entry point. By defining the loss limit and potential participation in advance, capital preservation notes can reduce the temptation to react to short-term market moves. They may be especially useful for investors with concentrated portfolios, substantial accumulated gains, lower drawdown tolerance, or a desire to add equity exposure more cautiously.

These potential benefits come with important trade-offs. Capital preservation generally applies only at maturity, and an early sale may generate a mark-to-market loss. Participation in gains may be limited, investors do not receive dividends from the underlying equities, and repayment depends on the creditworthiness of the issuer. Liquidity, product complexity, and the effect of interest rates and option prices on the participation rate also require careful consideration.

So, we expect further gains for broad equity markets over the next six to 12 months, supported by resilient economic activity and broadening earnings growth. We recommend maintaining diversified core equity exposure while reducing concentrated single-stock positions.