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Principal Protected Notes (PPNs)

PPNs and index-linked GICs are classified as structured products because they are generally a pre-packaged investment strategy that are based upon derivatives, baskets of securities, options, indices, commodities, debt securities, foreign currencies, etc. This is a more complicated investment for the novice and more difficult for estimating your investment costs.

Like bonds, these investments do not trade on an organized stock exchange, but rather a single or a small number of financial institutions will organize and maintain the secondary market where these trade once purchased by investors for these products.

Typically, a financial institution agrees to guarantee 100% of the investor’sprincipal, as long as the PPN is held to maturity. In addition,the PPN's actual investment rate of return is not guaranteed, as is the case with a bond or traditional GIC, but rather the resulting rate of return is dependant upon the success or failure of the underlying or linked stock market index, mutual fund, baskets of mutual funds, basket of common shares, etc.

Note: These types of investments are expensive to design, market, and manage, and as a result the investment costs are very high. For example, the financial institution that guarantees the investment’s principal will charge a fee, the institution managing the linked underlying exposure will charge a fee, and the institution marketing the PPNs and their representatives will also need to be paid.

What is your cost to purchase a PPN?

The cost to purchase a PPN typically maintains the following cost structure:

  • Selling agent’s fee:  up to 5.00%
  • Set-up fee:  up to 1.75%
  • Annual management fees:  up to 3.00%
  • Performance fees:  up to 20% of returns above a benchmark return.
  • Swap fees:  not disclosed
  • Brokerage fees:  not disclosed

Unfortunately, PPNs are not regulated like mutual funds and other investments. This makes it very difficult foran investor to know exactly what investment costs accompany the purchase and ownership of PPNs.

In Canadian law there exists an exemption in the definition of a security for certain bank-debt instruments (such as PPNs), which means they are not regulated by the securities commissions in this country. As an unregulated, exempt security, the issuing financial institutions are not required to accompany the issuance of PPNs with a prospectus.  (A prospectus requires that the fee and cost structure be identified and explained for investors.)  As a result, investors have a difficult time calculating the transactional and annual investment costs associated with PPNs and index-linked GICs. (In other words, as there is no regulating body overseeing these options, buyers must beware!)

Note:  For more information regarding PPNs and index-linked GICs, see our sections Class Room - Investment Type: Principal Protected Notes.


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