During the late 1990s and early 2000s, PPNs, also known as structured notes, were introduced into the American financial services marketplace as a hedge against market volatility. At the end of 2008, the structured note market, led by Lehman Brothers and other household banking names, came tumbling down like a house of cards. PPNs had touted their ability to protect investor principal while also capturing excess market returns. “Immune from the Bear and amiable to the Bull” was their unofficial motto. Downside risk was protected through insurance contracts while upside potential was possible linking the underlying investment to a market index.

PPNs may have sounded like the great financial innovation of modern investing, but in retrospect, these contracts failed to deliver value to investors. Excessive fees, questionable insurance premiums, and good old-fashioned investment risk all contributed to demote PPNs from their star status.

Factors Impairing PPN Rate of Return

The essential selling point of a PPN is a guarantee – if you invest $100 today, in five years you will receive at least $100, and possibly much more if the market does well. However, is a dollar five years from now worth a dollar today? A little nuisance called inflation has a tendency of reducing dollar purchasing power over time. So, the investor will actually be worse off financially by simply having his or her capital returned at some point in the future. Plenty of preservation-of-capital investments exist that actually keep pace with inflation, thus rendering irrelevant this most touted PPN benefit.

Sellers, or issuers, met with this objection often switch gears to emphasize the PPN upside potential. If the market does well, the returns could reach 20%, 30%, or even 40%. However, after the investor bites on this sales pitch, a myriad of fees begin to emerge. First, the seller will most likely take a sales commission. Then, of course, an ongoing management fee will be required. And most certainly, if the investor cancels the contract prior to the end of the period, a substantial early redemption fee will be charged. The fee for the guarantee, essentially a small insurance contract, must also be handed over to the investment company. As the old cliche cautions, a guarantee is only as good as the guarantor, and many PPN guarantees have failed. All of these fees shave off precious percentage points from the contract’s overall return.

You might be curious why these notes garnered so much demand given the listed shortcomings? Two reasons: First, the note is a one-stop purchase without the corresponding intimidation of unfamiliar investments like options and futures. Second, most investors and RIAs are ill equipped to create the same exposure in non-synthetic form. The investor is almost always better off investing directly in the underlying components of the synthetic PPN.

How Your Investment Advisor Can Help

The best alternative to an off-the-shelf PPN is to meet with a registered investment advisor qualified to design a personalized portfolio of zero coupon bonds, index options, futures, and other appropriate investments.

Taking this approach cuts out the massive fees associated with the PPN packaging.

Further, a competent advisor will seek to understand the investor’s financial goals and create an overall plan to achieve the desired results. Investor risk tolerance, time horizons, tax minimization needs, liquidity requirements, and fee transparency can all be incorporated into a cohesive investment strategy.

The smokescreen of the PPN simply cannot compete against such a direct and comprehensive strategy.