The fine print for principal protected notes

The Stterlliing Report

With Dian Blackwod

Sunday, April 06, 2014    

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THE market consists of quite a number of structured investment notes but not all fit the risk appetite of every client. Each client is unique and looking for different exposures, returns, risks and maturities. With all these variables in mind let's examine Principal Protected Notes to ascertain who will consider them suitable for their portfolio.

Principal Protected Notes or PPNs guarantee an investor, the principal amount of his/her original investment upon maturity. They have a face value and a maturity date. However, the return on PPN's is usually tied to an underlying asset or index. The investment therefore returns principal plus the return generated by positive movements in the underlying index/security. If there are no positive movements, the issuer gives the investor back his principal only. These investments are tailored for risk-averse investors wishing to protect their investments while still retaining the potential for higher returns generated by upward movement in the market.

For example, if you invest US$10,000 in a PPN indexed to the Dow Jones Industrial Average for five years, for every one per cent the Dow is up you would get a one per cent return on your note. If the Dow is up 50 per cent over five years then at the end of the five-years you would receive $15,000 ($10,000 + 50 per cent X 10,000). If the Dow, however, goes down, the client will receive only the initial amount invested: $10,000.

PPNs, as the name suggests, offer principal protection, growth potential and diversification. PPNs offer clients exposure to a wide variety of underlying assets that they would not ordinarily want to be exposed to, such as stocks, mutual funds, indices, commodities, and currencies.

A closer look

Investors are always encouraged to do extensive research, with the help of a financial advisor, on structured investment products and services.

It is essential to first ascertain if the entity providing the guarantee is fiscally sound, solid and safe. Your principal is only as safe as the issuing institution.

Another factor to consider when purchasing these notes is opportunity cost. If the underlying asset/index did not perform as well as you had predicted, you would have lost the opportunity to invest your funds elsewhere. This is where a keen financial advisor is needed to thoroughly understand and watch the performance of the underlying securities to assess the likelihood of upward movements. Also, the advisor will investigate if the possibility exists for breaking the investment, how much the investor can take out in case of emergencies and how often. It is very important for investors to consider their liquidity needs before investing in PPN's. For the most part, these investments are generally intended to be held to maturity.

Is it for you?

After you have collated all the necessary information on the PPN's and the underlying securities ask yourself the following questions:

*Do you wish to participate in specific markets without taking on the full risk of losing your initial investment?

*Do you wish to include fixed-term investments as part of your portfolio?

*Do you believe in a buy and hold investment strategy?

*Do you prefer investments that do not require active management?

The PPNs provide a level of security. However, you the investor need to be comfortable with the underlying investments. Like any other investment, do your homework before taking that step and be sure to read the fine print.

Dian Blackwood is Assistant Vice-President --Financial Planning with Sterling Asset Management Ltd. Sterling provides medium to long term financial advice and instruments in US and other world market currencies to the corporate, individual and institutional investor. Contact: or visit or follow @SterlingAssetM1 on Twitter.





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