What are PPNs?

PPNs offer the prospect of earning a rate of return above what might be provided by a guaranteed investment certificate (GIC) or other investment providing a fixed return.

With a PPN:

• As with a GIC, the capital you invest is guaranteed. In other words, you won’t lose your initial investment, unless the financial institution that guarantees the PPN declares bankruptcy (PPNs are generally not covered by the Canada Deposit Insurance Corporation or by the AMF).
• You could make an additional profit, but this isn’t guaranteed.

PPNs are marketed under various names (“linked notes” or “return notes”). They are subject to various conditions.

What should I know about PPNs?

Before you buy a PPN, you should know that:

• There may be little or no profit on your investment.
• Your money is locked up for several years. If you take it out early, you can lose the guarantee on your principal. You may also have to pay a fee.
• Various PPN fees can reduce the profit on your investment, even if it generates a good return.

Understanding the characteristics and risks related to this type of investment can help you make a better decision.

How do PPN managers guarantee the capital?

Here is one way of doing this:

• Investment of $100.
• The manager puts $70 in an investment that will accumulate interest for 10 years.
• By the end of the guarantee period, the $70 will have grown to $100 because of the interest earned on it.
• The bank or insurance company that manages the investment of $70 guarantees a reimbursement of $100 after 10 years.
• The remaining $30 is put in an investment that is riskier but that might generate a bigger return.

What are the risks associated with this type of guarantee?

Once again, using the same example of a $100 investment and a 10-year guarantee period:

1. If you take any of your money out before the 10-year guarantee period expires, you could:
   • lose the guarantee on your principal
   • have to pay a fee
   Note that some PPNs are not redeemable before the end of the guarantee period.
2. The guarantee on the reimbursement of the principal depends on the financial position of the institution providing the guarantee. In the event of bankruptcy, the guarantee no longer exists. Although PPNs are sometimes referred to as deposits, they are rarely insured by the Canada Deposit Insurance Corporation or the AMF.

What can I do about these risks?

Determine if the value of the guarantee suits you by answering the following three questions:

1. Can I allow these funds to be locked up long enough to benefit from the guarantee?
2. How reliable is the guarantor providing the guarantee to the PPN managers and the investors?
3. Is the PPN insured by the Canada Deposit Insurance Corporation or the AMF?

How do PPN managers make a profit for investors?

Once again, using the same example of a $100 investment and a 10-year guarantee period:

1. The PPN manager puts $70 in a guaranteed investment that provides at least $100 after 10 years.
2. That leaves $30 (minus any selling commissions) to generate the profit for your entire $100 investment.
3. The PPN manager invests this amount in products that could generate a high enough return.

In this example, some PPN managers take a bigger risk on your $30 to try to obtain a higher return. Generally speaking, however, a higher risk is accompanied by a greater likelihood that there won’t be any profit on your investment.

How can I minimize the risk?

To understand the risks associated with a particular PPN, ask yourself the following questions:

• What are the risks associated with the investments in which the PPN manager will invest the $30?
• Based on your investment goals and assets, how much risk are you comfortable with?
• Are the risks associated with the investments chosen by the PPN manager acceptable to you?

What fees are associated with PPNs?

PPN managers decide the amount and kind of fees to charge.

• Selling commissions
• Management fees
• Performance fees
• Structuring fees
• Operating fees
• Trailer fees
• Early redemption fees
• Swap arrangement fees

How can I properly assess returns on PPNs?

To determine whether or not the return on your PPN investment will be satisfactory, answer the following questions:

1. What is the total amount of PPN fees you will have to pay?
2. What rate of return can you expect from the PPN?
3. After taking into account the cost of the fees, is the rate of return satisfactory to you?
4. Are returns capped?

Getting answers to all your questions

If you’re interested in the concept of PPNs, contact a registered investment dealer. He can help you:

• Assess whether the conditions of the guarantee are adequate for your investment needs. For example, does the guarantee require you to lock up your money for a period of time that doesn’t suit your investment objectives? Can you afford the fees if you withdraw your money before the guarantee period expires?
• Verify the reliability of the guarantor providing the guarantee on your principal. The guarantor is usually a bank.
• Review the security backing the guarantee to ensure it is adequate.
• Determine if the PPN is insured by the Canada Deposit Insurance Corporation or the AMF. This is rarely the case.
• Identify the risks of the PPN managers’ investment strategies to see if they match your investing profile and risk tolerance.
• Calculate the estimated rate of return on the PPN, check if it is realistic, and if not, make a reasonable estimate.
• Calculate the total amount of fees associated with a particular PPN investment and assess how that will affect your return on investment.
• Determine whether other investment strategies would be more suitable for you. For example, you can ask whether proper diversification using other investment products suits your investment profile and can achieve your investment goals on a less restrictive and less risky basis than the PPN you’re considering.

To thoroughly assess your financial needs and goals and determine if a particular PPN investment is right for you, your investment dealer may have to do some research. The PPN manager’s investment strategy and the PPN’s fee structure may be very complicated.