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Principal Protected Notes hit the spot with many risk-averse investors

by Wayne Cheveldayoff, 2006-03-02

The great variety of principal protected notes (PPNs) currently on the market are potentially rewarding to investors seeking better returns than GICs and bonds.

But PPN structures can be quite complex and investors need to spend a lot of time working through the details to know exactly what they are getting.

A good example is the latest offering from Pro-Performance Asset Management (, namely the Pro-Performance Blue Chip Yield Deposit Notes Series 1.

The idea behind these deposit notes, as with all PPNs, is to provide investors with the opportunity to earn higher returns than current interest rates on bonds or GICs but with the original investment guaranteed and returned by a bank when the notes mature – typically in five to 10 years, though in this case it is eight years.

The main variable, then, is how much interest will be paid on the notes.

The potentially higher returns offered by PPNs usually come from linking the notes to the performance of a broad stock index, a narrow basket of stocks, mutual funds, futures or commodities.

Many investors are attracted to the 100-per-cent principal protection and this has caused the PPN market to mushroom to almost $10 billion.

For the Pro-Performance Blue Chip Yield Deposit Notes, the potentially higher interest returns will come from linkage to a basket of 30 well-known international stocks chosen from the Dow Jones Global Titans 50 Index, according to the accompanying 35-page information statement.

The 30 stocks include Abbot Labs, Altria, Astrazeneca, Barclays, Bellsouth, BP, ChevronTexaco, Cisco, ConocoPhillips, Dell, ENI, Exxon, GE, GlaxoSmithKline, Intel, Merck, Morgan Stanley, Nokia, Phizer, Roche, Samsung, Siemens, Walt Disney, Time Warner, Total Fina Elf, Toyota, Verizon, Vodafone, Wal-Mart and Wyeth.

While these stocks, individually and as a group, will determine the ultimate interest earnings on the Pro-Performance notes, the linkage is not direct, and this is where it becomes rather complicated.

For starters, no matter what happens to the basket in the first two years, the notes will pay a guaranteed 6 per cent yield in the first year, and 5 per cent in the second.

In subsequent years, the interest paid out every six months will be determined by the price of the 30 stocks according to a specific formula, but capped at a maximum of 10 per cent a year (5 per cent every six months).

In order to obtain the maximum 10-per-cent annual interest returns throughout the final six years of the notes, all that has to happen is that the price of each of the 30 stocks goes up 5 per cent within the first 30 months – not 5 per cent a year or 5 per cent every six months, but just 5 per cent from the time the notes are issued at the end of March.

Once a stock goes up 5 per cent, there is a lock-in provision for that stock, meaning it is counted as having completed its objective in each subsequent six-month period when interest returns are calculated – even if the price of the stock subsequently goes down.

It is unlikely that all of the stocks will go up 5 per cent in the first 30 months. Pro-Performance back-tested the basket and found the average annual return that would have been earned on identical eight-year notes had they been issued on each business day from Jan 4, 1990 to November 25, 1997 would have been 8.3 per cent. The minimum would have been 6.33 per cent and the maximum 8.88 per cent.

So, in summary, in addition to getting their principal back after eight years, investors stand to get an annual interest return as low as 1.38 per cent (if all that is paid is the guaranteed interest coupons in the first two years) or perhaps up to 10 per cent (if all goes well).

Paris-based BNP Paribas, the world’s third largest banking group, will administer the notes, calculate and pay the interest and guarantee to return the principal upon maturity.

Somehow BNP will make money doing it, but there are no annual management fees deducted. For its marketing efforts, Pro-Performance earns a fee from BNP of 2 per cent and advisors selling the notes earn a selling commission of 4 per cent.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at and he can be contacted at

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©2006 Wayne Cheveldayoff