A “principal protected note” (also known as a “principal protection note” or a “structured note”) is a structured investment product that combines a bond with a derivative component—and offers a full or partial return of principal at maturity. Typically, these notes do not represent ownership of a portfolio of assets, but are actually promises by the issuer of the note to pay returns based on the performance of an underlying asset, index or benchmark. Some of the more commonly cited market benchmarks include principal protected investments with links to the S&P 500 Index, Global Index Basket, Asian Currency Basket, and Spread between 30 year and 2 year swap rates. The terms of these structured notes can also be more complex than traditional bonds, making them more difficult for investors to evaluate.
In recent years, the retail market for structured notes with principal protection has been growing, but losses in principal protected notes have been increasing as well.
Questions about a PPN you own?
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Investing in a PPN?
There are many important considerations for individuals considering investing in principal protected structured notes:
- Investors of principal protected structured products do not own the reference asset and have no right to the dividends or price appreciation of the reference asset.
- The payout of structured products is driven by derivatives, making them highly risky for most investors.
- Structured products are unsecured obligation of the issuer. If the issuer defaults, investors can lose their entire investment.
- Structured products are illiquid investments. There is usually little or no secondary market and the issuer is not required to buy them back if the investor needs to cash out.
- Oftentimes brokers selling structured notes do not fully understand how the products work and what the risks are, they cannot explain the risks to their customers.
Are PPNs Safe?
No, principal protected notes, even those touting “100% Principal Protection,” “capital guarantee,” “absolute return,” “minimum return” or similar terms, they are not completely risk-free. Any promise by the issuer to repay some or all of the money you invest depends on the creditworthiness of the issuer of the note—meaning you could lose all of your money if the issuer of your note goes bankrupt. Also, some of these products have conditions to the protection or offer only partial protection, so you could lose principal even if the issuer does not go bankrupt. And you typically will receive principal protection from the issuer only if you hold your note until maturity.
It is important for investors to realize that the risk of loss of principal is very real, even when structured products feature a principal protection guarantee. So-called “100% principal protection” notes issued by Lehman Brothers Holdings lost most of their value when Lehman went bankrupt because the notes were an unsecured obligation of Lehman.
Do PPNs Have Fees?
Yes, virtually every investment has either implicit or explicit fees, whether they are described as selling commissions or concessions, management fees, structuring fees, early redemption fees or by some other term.