Auto-Callable Notes | Note Investing

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1) Auto-callable notes are a really neat investment product that have gained a ton of traction, especially in the last 10 years and it could be a fit for your portfolio.

Historically, it was quite simple.


2) You had an underlying asset and for this example we’ll use the TSX composite index XIU, which is an underlying index.

An issuer, usually a bank, would issue a note. More specifically, an auto-callable note is an investment note structured and issued by a bank where the underlying asset was measured and will be evaluated at specific intervals.

Now over time, they've become much more complex and there's a whole bunch of different features that can be included.

There can be a contingent income coupon where it gets called, but you also pay an income provided an underlying asset class is not minus 30% or minus 40%.

You can get a principal protected callable feature where the entire principal is protected and you only get called if it's positive.

You could also get some step-down callable notes in year one, as long as it's positive.

However, in year two, as long as it's not minus 5% or worse, you get called as well.


3) The callable features can vary, fluctuate, and could very well have a different number.

The coupon certainly varies. You may get some that pays much more upfront and smaller at the back end. These are very unique and extremely customizable. They're issued typically by all Canadian banks.


4) Now who do they belong to? What are you replacing here?

This is typically not considered as fixed income. Although, it does pay a fixed income portion and even though the taxable consequence of the income is completely considered interest income, it should not be confused with your typical fixed income.

These are most often than not, replacing equity in most portfolios.
c) In your portfolio, auto-callable notes are allocated to equity.


5) Now, the reason why some would consider it useful is because you are able to streamline the income over time. Instead of getting the big swings of the equity markets (the 20% ups and the 20% downs), in theory, you can smooth it out.

Now these can be created on any sector like energy, American securities, Canadian securities, Canadian bank stocks, preferred shares, gold miners.


6) Make sure to talk to your tax professional about the tax consequences of the income. Talk to your advisor about how you think it fits in your portfolio.

They certainly make sense for some people and it makes sense for the people who want to reduce volatility in their portfolio and potentially create a consistent income stream with a predictable outcome.


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