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By Rob Carrick
The Globe and Mail
Report on Business
Tuesday, April 4, 2006 |
Yet another reason to take a pass on principal-protected notes: Lots of investment advisers don't like them a bit and are keeping clients away.
Adrian Mastracci, investment counsel at Vancouver’s ‘fee-only’ KCM Wealth Management, says, “The bottom line is whether the costs are worth the potential benefits. I prefer other alternatives for my clients.”
You can always unearth a contrarian adviser to trash an investing fad of the moment such as PPNs. But it's rare to hear as much widespread negativity as there is being directed at these supposedly conservative instruments for playing the stock market, commodities, hedge funds and so on.
"I can't believe (well, sadly I can) that the investment industry can promote these things and look at themselves in the mirror," Robert Smith, a certified financial planner in Markham, Ont., wrote in an e-mail. "I am in the industry and avoid these things for my clients like the plague."
Here's Toronto-based adviser Pascal LaRouche on PPNs: "I have been talking my clients out of them ever since they hit the markets."
Here's Montreal-based Jean Luc Fournier: "I have been a securities broker for the last eight years and I do not recommend this investment vehicle. If a client insists on having them, I get him to sign a paper saying that this was not my proposed recommendation."
PPNs allow you to invest as little as $5,000 in portfolios of stocks, stock indexes, commodities, hedge funds or mutual funds, with a guarantee from a major bank that your worst outcome will be to get your principal back after a term of three to 10 years.
Conceptually, PPNs sound attractive if you're the sort of conservative investor who still hasn't shaken off the trauma of the bear market that began this decade. In practice, PPNs are a finely tuned machine for extracting money from unsophisticated investors and transferring it to banks, brokers and those advisers who are willing to sell them.
The fees are stiff with PPNs, and they're inadequately disclosed. Same goes for the formulas used to determine how much benefit investors will get from increases in the value of the underlying product. Such are the drawbacks of buying an investment that guarantees you won't lose money (not counting inflation, of course).
Advisers have sold lots of PPNs to clients in the past couple of years, a period in which assets in these securities have doubled to about $7-billion. But as some advisers drill down into the details of how particular PPN issues work, they're making a decision to avoid this product altogether.
Frank Arnold, an adviser in Victoria, recently dissected a PPN that offered exposure to global financial companies. By his estimation, the investor would lose out on roughly 50 per cent of the total return of these stocks (that's share price appreciation plus dividends). In return, investors get an unneeded guarantee that the share prices of seven of the world's largest and strongest financial firms will be worth more in six years than they are today.
"I suspect that many unsophisticated advisers that use [PPNs] don't know how atrocious they actually are," Mr. Arnold said.
Mr. LaRouche, the Toronto-based adviser, described PPNs as something that pension funds and other institutional investors would never put their money in. "One of the first questions I ask myself when I am presented with a new investment option is, what is the likelihood of an institutional investor investing in this product? If the answer is that such an entity is unlikely to invest in it, I ask myself, what outstanding reason is there for me to recommend this to an individual client?"
Vancouver-based adviser Adrian Mastracci said his issues with PPNs include the high fees, the lack of clear information on how they work, the limited market for selling them before maturity and the fact that inflation undermines the capital guarantee.
"The bottom line is whether the costs are worth the potential benefits," Mr. Mastracci wrote. "I prefer other alternatives for my clients."
It's not just advisers who don't like PPNs. "I have always felt that everyone involved in PPNs makes money," wrote one Toronto money manager. "That is, everyone except the poor fellow who makes the investment."
Sonny Young, a Toronto-based chartered accountant, said he almost invested in PPNs recently, but opted out after reading the details on how they work. "I found the information extremely hard to understand even after meeting with the people involved including my financial planner," Mr. Young wrote in his e-mail. "I spent over eight hours rereading the information and still ended up confused."
Fans of PPNs in the advisory world insist they're a good option for conservative investors, and that there are bad and good examples. Maybe so, but the people who dislike PPNs are awfully persuasive.
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