Martin Pelletier: Utilizing structured notes is a strategy that has worked particularly well for us
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The deadline for your 2023 registered retirement savings plan contributions is approaching, so it may be a good time to review the investment strategies you’re deploying.
Some advisers recommend holding more bonds within RRSPs due to their unfavourable tax treatment, which worked reasonably well until higher interest rates kicked in two years ago and sent bond prices much lower. Others have put in growthier investments, which has sometimes been a winning strategy, especially for those owning the tech-heavy S&P 500 lately.
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One strategy that has worked particularly well for us is utilizing registered products for structured notes since they, too, are taxed at the highest rate compared to capital gains and dividends.
Structured notes take an equity exposure and turn it into an income vehicle for investors with embedded downside protection. This downside is obtained by giving away the upside beyond the coupon being offered, although there are strategies such as boosters that do track the upside.
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For those in a registered retirement income fund (RRIF), notes can be helpful, especially the monthly contingents that pay a yield in the high-single to low-double digits, complemented with downside barriers ranging from 20 per cent to 50 per cent.
For example, in today’s environment, one can do a contingent note on the Canada Blue Chip AR index (comprised of a near-equal weighting of Manulife Financial Corp., Bank of Nova Scotia, TC Energy Corp., Canadian Imperial Bank of Commerce, Telus Corp., Pembina Pipeline Corp., Toronto-Dominion Bank, Enbridge Inc., Great-West Lifeco Inc. and BCE Inc.) that will pay a nine per cent annualized coupon monthly as long as these stocks collectively don’t fall more than 30 per cent.
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If they do, the coupon payment would be missed that month, but would have to stay below 30 per cent each month to not get paid. Assuming the note isn’t called away and it makes it to the end of the seven-year term — they are callable every six months if they are collectively five per cent higher than at the starting date — you are fully protected as long as it doesn’t remain below 30 per cent at the end of this period.
Therefore, assuming it makes it to year seven, if the index is down 29 per cent, you get all your principal back and don’t forget all the coupons you received over the years, which would yield a much higher return than owning the stocks themselves. If they are down more than 30 per cent, then you lose that amount offset by the coupons paid out, but one can add a buffer to temper the losses below that 30 per cent barrier.
Younger investors can also utilize notes within their RRSPs, such as more aggressive auto-callables that pay an annual coupon in the low-double digits if the underlying index is zero per cent or higher on a yearly basis.
For example, one can currently do an auto-callable on the aforementioned Canada Blue Chip AR index with a 20 per cent downside barrier. If the index return is more than zero per cent in a year, the note is called away and you receive your principal back and a 23 per cent coupon.
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If its return is below zero per cent, it carries over to year two, and if more than zero per cent, then the note gets called away and you get your principal back and a 28 per cent coupon (14 per cent per year). In subsequent years, it has the same structure, but coupons of 33 per cent, 38 per cent, 43 per cent, 48 per cent and 53 per cent.
This is front-end loaded, but there are other structures that offer a more even distribution of coupons by year, starting at 16.5 per cent followed by 33 per cent in year two, 49.5 per cent in year three and so on.
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We run the majority of our client’s registered portfolios in these types of investments given they align quite well with our risk-managed, goals-based philosophy and approach.
Having a portfolio of these notes make a lot of sense since they can be diversified and structured according to your risk willingness and ability. More so, there is a huge value-add of not having to follow the ups and downs of the markets, and knowing that you’re earning a decent return while your capital investment is being protected.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
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