What is a PPN?
A Principal Protected Note is a form of a structured note and it’s a bond type instrument that’s issued by the banks.
Other forms of structured notes are autocallable notes and equity linked notes. We’ll focus on PPNs for today.
Usually the Canadian banks are issuing a lot of these in this space and they have a guarantee on the capital at maturity.
They’re very similar to bonds. They actually classify as bonds under the fixed income section in a lot of investment policy statements that we see.
This is why a lot of people are turning to them in mass.
The old alternatives to fixed income are bonds and GICs.
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Hypothetically, if you own a bond & you join a GIC, you’re sure to get a coupon for X many periods of years. There’s a guarantee, there’s an underlying guarantee on that coupon, which is the value of the bank that’s issuing these GICs.
In this case, when we look at PPNs, the guarantee is very similar. It’s a bank guaranteed instrument, but the payout is not, the payout is significantly different.
Instead of getting a five-year bond that pays 3%, a client will own a five-year bond or five-year PPN that will pay 100% of the performance of an underlying index.
In this example, let’s pretend one PPN that was recently issued by a bank pays 100% of the underlying performance of the Canadian bank stocks. So this PPN is guaranteed. The capital is guaranteed, and the client is assured that he or she will not lose one penny on this investment.
Instead of making 3% for five years, the client will make 100% of the upside, the positive price movement of those Canadian bank stocks. It actually gives you exposure to the stock market without having any risk.
These have become quite popular. They make a lot of sense for anyone who is risk averse and who wants to participate in the market. They also make a lot of sense for institutions. If you are heading up an institution, a conservative portfolio, you need to have nothing but fixed income and yet you want the returns that the equity markets can generate.
There’s an easy way to approach note investing, get the exposure to that through a bond-like instrument fully guaranteed and then you get to participate in the upside of the market. Usually they have anywhere from a three to eight-year maturity on these PPNs.
These principal protected notes, they would have done remarkably well in the last decade or so. Some of them matured at 10% plus annually. PPNs definitely have a place in some Canadian’s portfolios.
If you’re risk averse, if you want the growth and yet you want the liquidity that a bond-like instrument like a PPN can give you, then it’s certainly something to consider.
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You have to consider if PPNs do trade. There’s a secondary market and they trade on the secondary market, which means that they are marked to market daily.
Essentially, if the PPN traded at 94 cents on the dollar yesterday, you will see it on your statements at 94 cents on the dollar. It is not like a GIC, which will always show it at par or better. So that’s one thing to factor in and to consider, even though it’s got the guarantee, it might show on your statement at a loss.
I believe it’s a fantastic investment instrument. It makes a ton of sense for a lot of people.
It’s something fairly new and it likely makes sense for anyone who is defensive and anyone who wants more of the exposure with less of the market risk.