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Structured products have long been among the best kept secrets for Canadian investors and their advisors. They offer full principal protection if held to maturity, coupled with an equity-linked exposure and a variable degree of leverage. Yet, amid rising inflation, higher interest rates and looming uncertainty, the case for structured products has shifted – most notably for principal-protected notes (PPNs).
“Two years ago, principal-protected notes were used by investors who wanted higher yields than traditional fixed income because interest rates were generally so low. Now that we’re in a new market environment, people are looking at fixed income and GICs [guaranteed investment certificates] more because their interest rates are much higher,” says Benoit Belanger, manager of equity derivatives and structured products at Desjardins.
But it’s the potential for equities-like growth that’s catching investors’ attention. A PPN employs an option derivatives strategy. That can generate a variable return linked to the performance of an underlying portfolio made of an exchange-traded fund (ETF) or a basket of global stocks.
“The worst-case scenario is you receive your capital back at maturity. The best case is that if you have a high return on the underlying assets, your PPN will also generate a high return,” Mr. Belanger says.
Historically, investors often had to pick between protection, growth or income. With PPNs, they don’t. In addition, PPNs are highly accessible, with a minimum investment of $1,000, and available through most full-service and discount brokerages.
Several options available for investors
PPNs have been a good match for those in or approaching retirement who seek the potential for equities-like growth in their portfolios without putting their capital – and retirement plans – at risk.
The need for a combination of equity exposure and protection has arguably never been higher for these investors. Despite traditional fixed income generating high yields not seen in 15 years, inflation is also much higher than it’s been in more than a decade, thus eroding real returns.
“In contrast, the stock market is commonly considered a good way to beat inflation. So, using a principal-protected note can help maximize the probability to beat inflation long-term,” Mr. Belanger notes. “You’re able to get exposure to the upside of equities, which is potentially higher than an annual return on a GIC.”
PPNs have multiple return profiles compared to traditional asset classes. For investors with lesser appetite for risk, PPNs can be an attractive alternative to fixed income, providing potentially more attractive yields than current GIC rates. As a leader in structured products, Desjardins also offers leverage exposure to an underlying global equity basket.
“For example, if you’re very bullish on the market, you can have a five-year product with 150 per cent leverage that has an unlimited maximum return,” Mr. Belanger says. That means if the basket goes up by 40 per cent at maturity, investors will achieve a return of 60 per cent on top of their initial capital.
The perfect timing for PPNs
When interest rates were significantly lower, the maximum return potential on a PPN was less as well. That’s because bond yields were lower. So, more of the invested capital in a PPN went toward principal protection, with less left over to fund the option strategy that provided upside potential. Now, higher interest rates lead to better features on structured notes, which mean that principal protection has never been less expensive.
By lowering the cost of the portion designed to guarantee the PPN’s principal at maturity, there is more room for underlying equity exposure. That means potentially more attractive returns, Mr. Belanger adds.
Desjardins’ strong track record might give investors confidence too. The firm has more than 25 years of expertise in the structured product market, and last year received best manufacturer award from SPi (Structured Products Intelligence) Canada.
In September, Desjardins also earned two honours from the SRP (Structured Retail Products) Americas Awards: Best House, Capital Protection (based on overall sales and satisfaction for its principal-protected products, across the whole Americas); and Best House, Canada for the fourth consecutive year (based on overall sales and satisfaction for all its structured products).
For advisors and investors who have ignored the benefits of PPNs, Mr. Belanger has a simple message: “Structured products should always have a place in portfolios.”
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An investment in principal protected notes (PPNs) may not be suitable for all investors. Important information about principal protected notes is contained in the Information Statement and the Oral Disclosure Document of each note. Investors are strongly encouraged to carefully read this documentation related to a note issuance before investing and to discuss the suitability of an investment in the notes with their investment advisor or dealer representative before making a decision. The documentation related to a notes issuance in particular is available on the summary page of that issuance. In the event of any inconsistencies or conflicts between this document and the Information Statement, the Information Statement governs. The offering and sale of notes may be prohibited or restricted by laws in certain jurisdictions in Canada and notes are not offered for sale outside Canada. Notes may only be purchased in the jurisdictions where they may be lawfully offered for sale and only through individuals duly registered and authorized to sell them. Past performance is not indicative of future performance. The return on principal protected notes is dependent on the change (which may be positive or negative) in value of the underlying assets during the term of the note and it is possible that there may be no interest payable to the investor. The return on a note cannot be established before maturity. Some notes may be subject to caps, participation rates and other limits which feed through to performance. The full principal amount of a principal protected note will be repaid at maturity only. An investment in notes is subject to certain risk factors. Please read the Information Statement and Oral Disclosure Document for complete details, including the precise formula for determining return on a note.
The PPNs will not constitute deposits that are insured under the Deposit Institutions and Deposit Protection Act (Québec), the Canada Deposit Insurance Corporation Act or under any other deposit insurance regime.
Structured Retail Products (SRP), a division of Euromoney Global Limited, is a research firm founded in 2001 in England, providing news, data, research, event and training services related to structured products. SRP provides manufacturer and distributors awards. On the manufacturer side, the manufacturers with both more than 10 striking products and more than 10 maturing products, during the March 1, 2022 to March 31, 2023 period present in the SRP database were in contention to win one of the manufacturer awards, the contenders with the top ratings winning the awards. For the Best House awards, ratings are calculated by taking each contender’s results with the following weightings: annual sales as in SRP’s database in the year to the end of March 2022 with a 50% weighting; and survey score with a 50% weighting, the survey score being based on the average rating across various criteria given to each contender by the survey respondents. Desjardins received the Best House, Canada award. All rights reserved.
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