The inside scoop on a new alternative to bonds

With bond yields worldwide continuing to plumb record depths, could PPNS prove to be a promising substitute?

Conventional portfolio diversification involves some mixture of high-risk, high-yield stocks and low-volatility, low-yield bonds. But as National Bank Portfolio Manager Rob Tétrault explains in a BNN video report, taking on bonds nowadays comes with a severe sting.

“A crux of my education was portfolio theory. That was great in the 80s and 90s, and even 2000s… now, all-time low yields [are] the common question,” he says. “If you’re buying a 10-year Government of Canada bond, you’re basically accepting that for the next 10 years, you’re going to get 1% on your money.”

He also notes that while it’s tempting to strike bonds out from one’s portfolio altogether, most people can’t handle the volatility that comes from having an all-stocks portfolio. To fulfill the security function of fixed-income instruments, therefore, he recommends a couple of alternatives.

“One place I like is real estate exposure through a mortgage investment corporation,” he says. “The other thing you can do is you can structure a principal protected note or a PPN.”

PPNs are a debt instrument issued by a bank which guarantees full preservation of the principal. These instruments typically get a zero coupon rate, and at the end of the maturity period, the holder of the PPN gets the full principal, plus a percentage of the upside of an underlying asset class the PPN is linked to.

“It’s effectively a zero-coupon bond with derivatives attached to it,” explains Tétrault.

The tradeoff investors face in going for PPNs instead of bonds is that they’d effectively lose the consistent yield from coupon payments. Given the low yields most bond investors have to settle for, though, it may be a worthwhile cost to incur.

“You have to be thinking outside the box right now, and institutions–we have a focus on institutional accounts in my practice, and they’re moving away from the traditional, customary bonds towards this.”

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