Weather is one of the most powerful tools for improving predictability. Across disciplines, including economics, artificial intelligence, healthcare, investing and social sciences, research consistently shows that outcomes become more predictable as the time horizon lengthens. Volatility, uncertainty and interference tend to dominate in the short term, but over longer periods patterns emerge, risks balance out and confidence in outcomes increases. This is precisely the principle behind the growing interest in defined return investments.
What is a defined return investment?
Also known as “structured products” or “defined outcome investments”, defined return investments are instruments designed to guarantee a predefined return over a specific period of time. Their performance is tied to an underlying asset, often one or more stock indexes, but with predictable results, downside protection and limited upside potential, communicated in advance.
If used judiciously, these investments can allow you to obtain returns similar to those of shares in the medium to long term, with the following advantages:
default risk;
lower volatility than stocks;
a clearer trend for the defined period;
equity risk premium with a time margin.
At the heart of defined return investing is access to the equity risk premium, which is the excess return investors earn by holding equity securities rather than risk-free assets such as government bonds. While this premium is volatile in the short term, it has proven to be more predictable over extended periods. These investments allow you to take advantage of the premium in question while avoiding suffering short-term losses in the event of a market decline, thanks to long-term capital protection elements (for example by providing protection against the first 30% market decline).
Volatility risk premium
In addition to taking advantage of the equity risk premium, defined return investments also take advantage of another lesser-known risk premium: the volatility risk premium. This arises from the fact that expectations about market volatility are, more often than not, higher than the actual volatility that occurs. Through the use of derivatives, defined return investments take advantage of this premium, along with the equity risk premium, allowing you to access both simultaneously.
Behavioral and structural advantages
Volatility often leads to poor investment decisions. Faced with uncertainty and daily market swings, investors are more likely to react emotionally, panic sell, try to get ahead of the market, or abandon long-term plans.
Defined return investments overcome this danger in several ways:
provide clarity - with known outcomes and timelines, investors can plan with greater certainty;
manage expectations - these investments follow a specific formula, so traders can communicate to investors the likely short-term trend an investment will follow on its way to its final destination. This is extremely useful in allowing investors to focus on the long term rather than the short term, which is more unstable;
offer downside protection - reducing the emotional cost of holding your investment;
encourage a long-term view - the defined duration and structure help investors to “broaden the horizon” and stay focused on goals.
Imagine looking at a forest: up close, the chaos of individual trees and individual leaves may seem overwhelming, but just take a step back and the structure of the entire ecosystem becomes clear.
Time as a tool to manage volatility
Volatility is largely a function of time. Over the course of a day or a month, stock markets can swing wildly due to sentiment, news, or macroeconomic shocks. However, over a five-year period, these movements tend to revert to the mean and stabilize.
The law of large numbers, used in the insurance sector to predict mortality in different populations, finds a very similar parallel in the world of finance. While the movement of the VIX or a stock's price on a single day can be unpredictable, over time the aggregate patterns generally become stable and measurable.
Multi-asset portfolios and the role of defined return investments
In a traditional 60/40 portfolio (stocks/bonds), adding defined return investments allows you to obtain:
consistency of returns - narrowing the range of expected returns;
downside protection - mitigating market losses;
behavioral diversification - helping to reduce the likelihood of making impulsive decisions;
structural diversification - a unique return profile that is neither purely equity nor bond.
These investments are particularly useful for medium-term objectives, such as progressive risk reduction paths towards retirement, where it is necessary to find a careful balance between capital preservation and growth.
Broaden your horizon to grasp the signal
When you broaden your horizon with respect to short-term volatility, a clear long-term trend emerges: stocks outperform bonds, offering a risk premium of about double over extended periods. Defined return investments offer a structured way to participate in this long-term trend without suffering the full impact of short-term market swings, while taking advantage of another source of return: the volatility risk premium.
They allow you to broaden your horizon by setting a multi-year term, reducing impulsive behavior and improving portfolio discipline.
Bottom line: Manage time confidently
Defined return investments leverage time as a resource. By structuring equity exposure within a defined, multi-year framework, they allow investors to:
access the portfolio's main source of long-term return, namely the equity risk premium;
access another important source of return, namely the volatility risk premium;
protect investors from the risk of suffering losses due to short-term market declines;
improve predictability;
reduce behavioral errors;
Ultimately, defined return investments are tools for taking advantage of time itself, transforming short-term uncertainty into a long-term opportunity.
*Fund Manager, WisdomTree
