Structured product

A structured product is defined by the Canadian Investment Regulatory Organization (CIRO) as a "market-linked investment that is packaged as an alternative to a direct investment in the underlying security or basket of securities". CIRO includes principal protected notes and principal at risk notes in their definition, but banks also sell market-linked GICs under this general title.

Banks and brokers like to sell structured products; for example, as of April 2025, one investment bank lists over 6000 existing structured notes on its website. Another one lists over 2000 index-linked GICs, over 1000 principal protected notes and over 9000 principal at risk notes.

One academic paper, which looks at over 1500 principal protected notes from Canada in the UK issued between 2003 and 2015, notes that is is difficult for "retail investors to value structured products and to assess the unobserved premiums charged by the issuers. More importantly, the complexity of some products limits the ability of a retail investor to assess the risk, even with adequate information disclosure". For the over 1000 Canadian products studied, the underlying assets returned more than the structured product 82% of the time when dividends are taken into account.

Market-linked GICs

Main article: Market-linked GIC

Market-linked guaranteed investment certificates are a type of structured product that combines the security of principle of a GIC with some participation in specified equity market returns. They are also known as index-linked GICs.

Market-linked GICs appeal to investors who would like to enjoy potentially higher returns (compared to normal interest-bearing GICs), but are afraid to lose money in the stock market. In other words, these products "appeal simultaneously to our greed and our fear", which may help explain their popularity. They are typically sold in bank branches.

Principal protected notes

CIRO defines a principal protected note (PPN) as a "financial instrument where the return is linked to the performance of a specified underlying security or underlying basket of securities and at maturity the investor receives as a minimum, the initial amount invested".

What they are

PPNs are debt obligations of the issuing bank or credit union. Instead of paying fixed coupons, their return is linked to that of an underlying asset through formulas defined in the offering documents. They are comparable to index-linked GICs, but typically come without the CDIC coverage. Instead, the guarantee on the capital -- a guarantee which is only available at maturity -- is only from the bank or other issuer, relying ont its creditworthiness. If the issuying bank becomes insolvent, investors might only get back cents on the dollar, like happened in the US to people who purchased PPNs from Lehman Brothers in 2008.

PPNs are available on a wider range of underlying investments than maket linked GICs, including stock indices, custom baskets of stocks (see example below), but ranging up to commodities and hedge funds. The fact that PPNs allow "easy" exposure to 'alternative' asset classes can be part of the marketing.

The maturity is typically in 3 to 10 years but can reach 15 years. The principal protection is in nominal terms (before inflation). In real terms (after inflation), getting only the initial amount back after 10 years means a serious loss of purchasing power.

Return calculation example

Return calculations of PPNs can be quite complex, but a relatively simple example is the Desjardins Canadian Financial Groups Principal Protected Notes, Series 232, with an issue date of May 29, 2025 and a maturity in seven years. Even though this is a simple case, the information statement is still 32 pages long. This note provides equal weighted exposure to 5 Canadian Banks and 3 Canadian insurance companies. At the end of seven years, final stock prices will be compared to initial ones to calculate the 8 "reference asset returns", from which the "reference portfolio return" will be computed. A participation rate of 135% will be applied. The result will be the "variable return" of the note. At maturity, the investor will obtain the principal amount plus the variable return.

What's the catch? Dividends are not considered in those calculations, even though "the dividend yield of the Reference Portfolio at March 31, 2025 was 4.12%". Suppose that the annualized total return of the underlying stocks, including dividends, is 8.00% over the next 7 years. Taking out the dividends leaves 3.88% in price appreciation. Multiply by 135% and the PPN investor is left with 5.24% annualized return. This compares with an annualized return of 5.26% obtained in scenario 1 of the information statement. In scenario 2, the price return of the stocks ("reference portfolio return") is negative, so the investor gets no variable return.

Fees

Possible fees on PPNs include sales commissions, early redemption fees, as well as "management fees, performance fees, structuring fees, operating fees, trailer fees, and swap arrangement fees".

According to the Canadian Securities Administrators (CSA), "these fees can significantly reduce the returns that would otherwise be derived from the underlying investments".

Protection events

A feature of those products is that if the net asset value decreases to a certain point, a "protection event" or "knockout event" might occur. The note becomes "monetized", meaning that it "no longer carr(ies) any exposure to other underlying investments". This means that even if the underlying assets were to recover, the total return of the PPN will stay at 0%.

As a result of the great financial crisis, "by the end of December 2008, 169 PPNs were monetized across 12 financial institutions in Canada". This lead CIRO (then IIROC) to perform a compliance review in 2009. The findings were that "Most of the Dealer marketing material was not adequate on its own as some key information was absent, such as information about the possible protection events (monetization events). Much of the marketing material examined also did not contain adequate information regarding charges and fees."

Liquidity

Another characteristic of PPNs is the typical lack of liquidity or at least limited liquidity. Morningstar writes that "while it's easy to buy them, selling them before maturity is a different matter altogether". There might be a secondary market for some PPNs, but issuers do not guarantee what value the investor might get if trying to sell before maturity (and there might be redemption fees as well).

Quoting from the information statement and oral disclosure document for the Desjardins note mentioned above:

The Notes will not be listed on any stock exchange. Desjardins Securities Inc. (“DSI”) intends to maintain until the Valuation Date, under normal market conditions, a daily secondary market for the Notes. DSI is under no obligation to facilitate or arrange a secondary market, and DSI in its sole discretion, may stop maintaining a market for the Notes at any time, without any prior notice to you. There can be no assurance that a secondary market will be available or that such market will be liquid or sustainable. (...) The notes may sell at a substantial discount on the secondary market.

Taxes

The returns to PPNs is classified as interest and taxable as regular income. This means that PPNs are not tax-efficient in non-registered accounts, compared to directly holding the underlying assets which tend to supply dividends or capital appreciation (instead of interest).

Have your cake and eat it too?

The marketing of PPNs can be quite aggressive, potentially implying that investors will get something like the safety of bonds and the upside of stocks or other risky assets. One major Canadian issuer is literally saying that "PPN investors can have their cake and eat it, too". PPNs are often sold to investors nearing or in retirement, especially those who may not "possess the complex mathematics, statistics, and computer skills necessary to evaluate structured products, even though they may have years of investing experience".

One industry veteran thinks that you can't actually have your cake and eat it too:

I think PPNs are a bad compromise. They serve neither equity nor income-oriented investors very well. Equity investors buy stocks to generate higher long-term returns on their portfolio. Higher returns come from taking more risk and being subject to some short-term volatility. If you take the risk out of the product (that is, principal-protection), it follows that you will also take out the excess return. Fixed income investors, on the other hand, buy bonds for the certainty they provide. PPNs provide no such certainty. PPNs are like the elephant in the room. Everyone in the investment industry knows these products are not good for the client, but they're keeping quiet about it. Why? Because PPNs are big sellers and generate terrific profit margins. Financial executives may ignore the elephant, but investors would be advised to give it a wide berth.

Principal at risk notes

CIRO defines a principal at risk (PAR) note as a "financial instrument where the return is linked to the performance of a specified underlying security or underlying basket of securities and the investor carries a risk of losing part or all of the initial amount invested".

Further reading

• Financial Wisdom Forum topic: "structured notes , Pelletier column"

External links

• Principal-protected Notes Regulations (SOR/2008-180)
• Financial Consumer Agency of Canada: Principal Protected Notes: know your rights
• Autorité des Marchés Financiers (Québec): Principal Protected Notes (PPNs)
• Rational Reminder Podcast, Episode 255: Structured Products
• Rob Carrick, Thumbs down on a popular investment pitched at nervous investors(subscription required)