Market-linked products that come with a guarantee of principal give your clients protection from a major market downturn while allowing them to participate when markets are rising.
Specifically, these products provide peace of mind to nervous clients who are worried about their RRSP nest eggs — although such products do so at the cost of relatively high fees or limits to growth potential.
Here is a closer look at the major categories of principal-protected products:
> Market-Linked Guaranteed Investment Certificates provide your clients with a guarantee of the principal invested while also offering them the potential for higher returns based on the performance of the underlying investment.
“It’s a segment that has been going strong lately,” says Carlos Cardone, senior consultant with Toronto-based research firm Investor Economics Inc., “especially since the market collapse of 2008.”
Usually, there are no fees associated with market-linked GICs. But issuers limit the amount of return that clients can earn, either through a participation rate — clients earn only a predetermined percentage of the performance of the underlying investment — or through a cap on the gains.
Market-linked GICs are most commonly available in three- or five-year terms and are eligible for coverage by the Canadian Deposit Insurance Corp.
> Principal-Protected Notes are fixed-income products that provide clients with a guarantee of the initial amount of the investment while offering returns based on the underlying investment — if the note is held to its full term.
The fees that are common for PPNs will reduce the level of the return, if any, the client eventually receives. These fees help pay for the guaranteed return of capital.
If there’s a significant drop in the value of the underlying investment, the PPN might experience a “knockout event,” in which the assets in the portfolio are moved entirely into bonds, ensuring that there is enough money to pay the guaranteed amount, but only that amount, at the maturity date.
With interest rates so low, issuers have been finding it difficult to structure PPNs that provide the guarantee and enough upside to make the product attractive. In turn, more and more issuers are offering principal-at-risk notes, which are structured products that offer greater upside potential than traditional PPNs but with only a partial guarantee of principal, or none at all.
> Target-Date Funds Featuring A Guarantee are mutual funds that periodically adjust the underlying asset mix to suit the changing risk profile of your client as a specified redemption date approaches.
Some target-date funds — such as IA Clarington Investments Inc.’s Target-Click Funds — guarantee the return of principal as well as allow unitholders to lock in a predetermined high level of net asset value. These features are paid for through the fees these funds charge.
As with PPNs, a steep drop in the market may create a “knockout event” for target-date funds offering a guarantee.
> Segregated Funds are insurance products with an investment component. They usually offer a 75% or 100% guarantee of the principal if held to maturity, usually a 10- to 15-year term.
Seg funds also may offer other benefits, such as creditor protection and the ability to bypass probate. The fees associated with a seg fund, which help to pay for the guarantee and any other benefits, tend to be higher than for a similar mutual fund.
Seg funds that offer a guarantee of income, as opposed to principal, have guaranteed minimum withdrawal benefits.
“The recent market volatility, combined with the demographic trend toward the aging of the population,” says Mark Probyn, director of product utilization with Winnipeg-based Investors Group Inc., “have made [GMWB] seg fund products very popular.” IE