Evaluating the Offering Documents for Principal Protected Securities

Marmorstein, Howard; Robinson, Thomas; Schulte, David; Trent, William
December 2006
Journal of Financial Planning;Dec2006, Vol. 19 Issue 12, p60
Academic Journal
In this adaptation from their newly released book from PPS Press, "Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements," the authors show advisors and their clients how to critically evaluate the offering documents for an increasingly popular hybrid investment called principal protected securities. Principal protected securities (PPSs) are baskets of equities that typically have fixed terms of five to seven years, at which point they "mature. " They guarantee the investor at least a return of principal, plus any accrued gains. PPSs have attributes of fixed income instruments as well as equities. These unusual investment characteristics bear close scrutiny in the offering documents. The article describes four common types or categories of PPSs. The first is high total return potential subject to periodic caps. The article examines this particularly complex category by scrutinizing a real PPS offering document, including the various return illustrations the document provides, and how the disclosure (and lack) of information aids and hinders the ability to analyze the PPS. PPSs structured as a percentage of index return are much simpler and more straightforward, and this is reflected in the prospectus example. But they, too, have nuances the investor needs to be alert for. The actively managed PPS with varying proportions of stocks and bonds discloses that it may increase the bond weight to ensure return of principal, thus potentially reducing or eliminating stock returns. Some PPSs defy any attempt at categorization, and there often are nuances to them that only the most diligent reader would discover. The example PPS uses 29 of 30 Dow stocks as its reference stocks and illustrates how the underperformance of even a single stock can dramatically reduce return.


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