In this educational series, we aim to to help advisers and investors better understand how various structured investments are assembled, what the potential returns look like, and the risks associated with the type of structured investment in focus. By advisers and investors a better understanding of what structured investments are, we hope to dispel some of the myths around structured investments and encourage investors to speak with their advisors to help them structure investments that are suitable for their risk profile, and portfolio objectives.
Education Series Part 1
In part 1 of the series, we look at Principal Protected Notes, a capital protected structured investment with a variable return that is paid at maturity, based on the performance of an underlying asset.
Investors seeking a balance between capital preservation and growth potential may consider Principal Protected Notes as an alternative to a traditional bond or other fixed interest investment. These instruments provide a unique blend of security and opportunity, making them an attractive option for conservative investors who also want exposure to market-linked returns.
Principal Protected Notes (PPNs) are fixed-term investments that guarantee the return of the principal at maturity while offering the possibility of additional returns based on the performance of an underlying asset. These assets can include stock indices, interest rates, commodities, or other benchmarks. PPNs typically consist of two key components:
Zero-Coupon Bond Component – This ensures that the investor’s initial principal is fully protected. The issuer purchases a zero-coupon bond that matures at the same time as the PPN and grows to match the initial investment amount.
Derivative Component – This provides the potential for upside returns. A portion of the investment is used to buy an option or other derivative tied to the performance of an underlying asset. If the asset performs well, the investor earns additional returns.
How do Principal Protected Notes Work?
When an investor purchases a PPN, their money is allocated into the two components mentioned above. Over the investment period, the principal is protected due to the zero-coupon bond, while the derivative component provides market exposure.
If the underlying asset performs positively, the investor receives a return based on the performance of an underlying asset, with a predefined participation rate or formula. If the asset underperforms, the investor does not lose their principal investment, but they do not gain additional returns.
Principal Protected Note Example
For this theoretical example, we will create a Principal Protected Note linked to the ASX200 on the following terms, please note that the below example is for illustrative purposes only:
- Investment Amount: $100,000
- Investment Term: 12 Months
- Underlying Asset: ASX200 (XJO)
- Participation Rate: 80%
- Principal Protection: 100%
Potential Outcomes
These outcomes are hypothetical only to demonstrate the potential returns of the example above. The investor that purchased the ASX200 Principal Protected Note example above would receive at maturity based on the performance of the ASX200 over the investment term.
Outcome 1: Market Growth
If the ASX200 increases by 10% over the 12 month Investment Term, the investors return would be calculated as follows:
- ASX200 return of 10% x Participation Rate of 80% = 8%
- Total Return: Principal of $100,000 + ($100,000 x 8% = $8,000) = $108,000
Outcome 2: Market Declines
If the ASX200 decreases by any amount over the 12 month Investment Term, the investors return would be calculated as follows:
- ASX200 return of -5% x Participation Rate of 80% = -4%
- Total Return: Principal of $100,000 + $0 = $100,000
In this example, the investor received their principal investment back, but made no further returns because the ASX200 had a negative return over the Investment Term.
These outcomes show how investors that would generally buy a bond or other fixed interest product, can invest in a product with some familiarity, but with the chance for a higher return.
Principal Protected Note Benefits
There are quite a few benefits for investors that choose to invest in Principal Protected Notes, especially for investors willing to risk a guaranteed return for a return that is potentially higher than bond yields and other fixed interest products. The main benefits of Principal Protected Notes include capital preservation at maturity and exposure to market linked gains.
Principal Protected Note Risks
As with all investments, there are risks associated with Principal Protected Notes. The main risks are credit risk of the issuer and hedge counterparty, and illiquidity – Principal Protected Notes are not liquid investments, and they cannot be redeemed before maturity, much like a traditional bond or fixed interest product.
Please note that this is not an exhaustive list of the risks associated with Principal Protected Notes, and you should review the term sheets for each product with your professional adviser before making any decision to invest.
Principal Protected Notes Summary
Principal Protected Notes can be a valuable investment tool for those who want to participate in market growth without risking their initial capital. However, investors should carefully assess the terms and in particular, participation rates, with their professional adviser before investing.
Anadara has just created Australia’s first Bitcoin linked Principal Protected Note as a part of our partnership with Monochrome. If you’re an adviser of investor that wants exposure to Bitcoin, but in a capital protected structure, get in touch with us. Or if you’d like to chat about structuring a Principal Protected Note linked to almost any tradable security from any of the major global exchanges, please get in touch with us to help you create a customised product for you.
As with any financial product, understanding the structure and potential payoff scenarios is key to making an informed decision. We highly recommend that investors speak to their professional adviser before choosing to invest in any of our products.
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