Principal Protected Notes Overview

Principal Protected Notes (PPNs) are a recent innovation in Canada, but one that has captured the attention of the investing public. A segment of the structured product investment category, Notes offer the promise of complete principal protection with the potential for equity-like returns.

PPNs are debt instruments that is, they are direct debt obligations of the issuing financial institution, typically a chartered bank. While Notes have bond-like attributes, their interest payment is variable, depending on the underlying investments to which the Notes are linked. They can be linked to a broad range of investment categories including baskets of equities, mutual funds, indices, hedge funds, commodities and income trusts. In all cases, PPNs come with a guarantee of principal repayment at maturity.

Overall, the goal of PPNs is to provide low-risk exposure to asset classes that are perceived to be risky by the investing public. Individually, PPNs can take a number of forms:

• some provide protection of original invested capital only, while others offer a capital guarantee that ratchets up with the value of the underlying holdings
• some are stand alone issues, while others are members of families of Notes
• some provide ongoing income streams, while others are focused purely on capital growth
• some offer the potential for leveraged exposure to the underlying investments

Since PPNs are typically issued by chartered banks (the guarantors) and are direct debt obligations of the issuing financial institution, it can be said that the quality of the guarantor determines the quality of the principal guarantee.

While PPNs guarantee invested principal, investors can also receive but are not assured of returns above that amount, depending on the performance of the underlying investments. It is important to note that, due to the complex structure of Notes, the performance of a Note will not necessarily track the performance of the underlying investments.

Finally, 100% of investors’ principal is guaranteed to be repaid only for those Notes held until maturity. Although terms of Notes can vary significantly, they are typically 7-8 years and, as such, are most appropriate for investors with long investment horizons.

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