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PPNs are hot this season

Advertisement Principal-protected notes are raining down upon the market as a multitude of manufacturers compete for the attention of advisors and their clients in the busy RRSP season. Although there hasn’t been much innovation in mutual funds this year, marketers of PPNs have been busy hanging bells and whistles on their products. The guarantee of the principal amount invested — providing the investor holds to maturity — applies to all PPNs. But this security blanket is being wrapped around a growing assortment of investments, including stock indices, individually chosen baskets of stocks, mutual funds, commodities and managed futures In some cases, leverage is used. In others, the guarantee is extended beyond the principal to lock in the gains made during the note’s holding period, no matter what happens to the value of the note after the high point was hit. “The category is exploding in Canada, and it’s becoming a crowded field,” says Dan Richards, president of Toronto-based Strategic Imperatives Ltd. “Investors are suffering a hangover from the tech stock implosion. They want to be sure they won’t lose money, and are willing to trade off some upside for protection on the downside.” Essentially, PPNs offer a guarantee on the amount invested, while linking returns to an underlying investment. The cost of this guarantee or insurance involves additional fees, which can shave a few percentage points off the returns investors would make by investing normally in the assets represented by the note. If the notes are held to maturity — typically, five to 11 years — the original investment will be returned to the investor intact. If the underlying asset increases in value, investors participate in the upside. Thanks to minimum investment thresholds of $2,000-$5,000, the notes have opened up alternative asset classes, such as hedge funds and managed futures, to retail investors. The most recent numbers provided by Toronto-based Investor Economics Inc. show 47 issuers, 300 notes and a $5.3-billion market. But these numbers are more than a year old (a new report is imminent). Some observers are guessing the size of the market may have doubled in the past year to $10 billion, and wouldn’t be surprised to see it swell to $100 billion in the next five years. To put that in perspective, the Investment Funds Institute of Canada measures investment fund assets at $570 billion. “The [PPN] product has become a must-have, and every financial institution out there is getting into the business,” says Earl Bederman, president of Investor Economics. “Due to demographics and the growing number of people entering retirement, more households are moving to the stage at which capital protection is important. At the same time, in a world in which interest rates are low, people who are investing to accumulate retirement funds are looking for some growth potential. We see the linked notes not as a temporary trend but as a permanent fixture of the marketplace.” The companies involved in PPNs include traditional fund companies as well as hedge fund companies and structured-product specialists. Typically, they partner with a Canadian chartered bank, government agency or major international bank, which backs the note with its guarantee. The strength and creditworthiness of the guarantor is of paramount importance, as the guarantee is the “backbone of the product,” says Robert Bourgeois, managing director of Tricycle Asset Management Corp. , one of the pioneers in the PPN industry. “Competition is leading to innovation and creativity. But the note product is also becoming increasingly complicated, and there are too many variations for the average advisor to track,” says Dan Hallett, president of Windsor-based Dan Hallett & Associates Inc. As an example of innovation, ONE Financial Corp. allows investors to switch among its family of 10 notes in a number of investment classes — including gold, energy, dividend income, income trusts, Asian investments and other regional options — and still maintain the original guarantee. These notes are also unusual in that they allow the holders to “lock in” profits on a daily basis, guaranteeing at maturity the highest value achieved at any point during the term. In addition, the notes are structured to provide the potential for enhanced upside returns by applying a leveraging strategy allowing up to 200% exposure to the invested assets. 1 | 2 | NEXT PAGE >> Read other news from our News Section