The unwinding of PPN's(principal protected notes) may have been a cause of some TSX selling today......
Investors told not to expect gains on PPNs
BOYD ERMAN
Monday, October 27, 2008
Thousands of investors across Canada have no chance of ever making any money on principal-protected notes they bought, even if markets rebound before the notes come due, highlighting the downside in the notes' structure.
Desjardins Group, Bank of Nova Scotia, Royal Bank of Canada, National Bank of Canada and Bank of Montreal have all given investors in some PPNs notice that their investments have undergone “protection events.”
That means the banks that sold the notes have had to give up on trying to make money for note holders because of losses in the markets, and now clients will only ever get their principal back when the investments come due.
The notes were marketed as a way to have the potential appreciation of an investment in the stock market with protection from any losses. But now, even if stocks rocket higher, the notes have no chance of paying back anything more than face value.
Given the alternative, though, sellers of PPNs say owners of the notes are taking the lost opportunity in stride.
“It's upsetting, but it's better than losing 40 per cent in the market,” said Vivek Jaitly, a Toronto financial planner who has sold PPNs to clients.
The notes are structured such that a large portion of the money is invested in a strip bond, a safe security that should mature at a value that will cover the full face value of the notes. That provides the principal protection.
The remainder of the original investment is put into the stock market, usually via a hedge fund or a mutual fund. To increase possible returns, the notes often employ borrowed money to add leverage.
Using leverage also means that losses multiply quickly. With markets declining, the money invested in stock markets has disappeared in a hurry. And, once it's gone, there's no chance of ever generating positive returns.
“The market could be up 500 points and it wouldn't do you a stick of good,” said Dan Richards, president of Strategic Imperatives Corp., a firm that offers advice to financial advisers. “Is it an easy conversation to have with clients? No. But it's probably not the hardest at the moment.”
The size of the PPN market is difficult to track, but 2006 figures put it at about $30-billion. However, not all outstanding notes are affected.
For example, National Bank of Canada has issued about $3-billion of PPNs and $2-billion of a similar product known as a variable guaranteed investment certificate since 2000. Only about $60-million are affected, said Isabelle Limoges, head of retail structured products at the bank.
She said there's still demand for the notes.
“People are scared and they're actually happy to get their principal back relative to some other types of products where they might lose much more,” Ms. Limoges said.
Mr. Jaitly, however, said he's wary of recommending the notes to investors now, even though the promise of getting full principal back might seem attractive in a falling market.
The concern is that there could be another round of “protection events” even on notes issued at today's levels if stock markets keep plunging.
In the meantime, investors must decide what to do with the notes they already have. Holding a PPN that matures in five or seven years only to get face value back in effect means taking a loss, because inflation will eat away a lot of the purchasing power of the principal.
“People are scared and they're actually happy to get their principal back relative to some other types of products where they might lose much more,” Ms. Limoges said.
With a file from reporter Tara Perkins
© The Globe and Mail
globeinvestor.com |
