Plunging stock markets and signs of a global economic recession have enhanced the attractiveness of a small category of mutual funds that combine “target date” investing with a lock-in of gains made along the way.

These funds, which come with varying maturity dates, offer inves-tors a guarantee of the high-water mark — the highest value ever reached by the fund — even if clients buy in after those peaks were reached. With equities plunging in recent weeks, there is an opportunity for clients to buy into these funds and receive guarantees on significantly higher values that were established before the market drop.

“If [investors stay] in these funds until the target end date, they will receive the highest value ever achieved by the fund, whether they were invested at that time or not,” says Mark Stewart, director of product development for Toronto-based BMO Mutual Funds Inc. which offers the BMO LifeStage Plus family of funds.

Although several fund companies offer life-cycle or target-date portfolios that invest more conservatively as the funds move toward their maturity dates, only a handful provide the enticing high- water mark guarantees. These include Toronto-based IA Clarington Investments Inc., the first retail fund company to enter the target-date fund market three years ago, as well as Mackenzie Financial Corp. and Bank of Montreal, both of Toronto, which introduced their fund families earlier this year. Target-date funds protect clients from market losses as long as they are held to maturity, while providing the long-term growth opportunities of a balanced global portfolio. While the Mackenzie and BMO funds reset their high-water mark on a daily basis, IA Clarington’s guarantee is based on the highest monthend value.

“As a result of recent declines in stock markets, these funds offer the opportunity to buy at a discount to their high-water marks,” says Rudy Luukko, investment funds editor with Morningstar Canada in Toronto, “and could be an attractive product in these volatile markets.”

Target-date funds come with various maturity dates, and clients can choose the date that coincides with their need for money. The funds typically have a high exposure to equities in the early years, and gradually become more conservative by increasing their exposure to income-generating securities as the target date approaches. The guarantor holds enough assets in the fixed-income portion of the portfolio or in a strip bond to meet the guarantee at maturity, based on the returns provided by compounding interest.

“The funds are great for nervous clients as they offer both a safety net and a life jacket,” says Kevin Cork, president of the Absolute Group Inc. in Calgary. “The guarantee has both a psychological and financial advantage. It helps clients manage their emotions and leads to better investor behaviour during market gyrations.”

However, if these funds hit a bad spell in the markets that erodes the value of their stock holdings, fund managers may need to switch some assets out of equities and into fixed-income to ensure that guarantees will be met. Thus, a client who buys now will receive the previous high-water mark guarantee, but, if the portfolio becomes substantially more conservative, it may miss out on the full impact of any market rallies. Funds with shorter maturities that must meet their guarantees at an earlier date have less time to recover from market slides and are more likely to have minimized their equities exposure.

For example, the Mackenzie Destination+ family includes four funds with maturity dates in 2015, 2017, 2020 and 2025. The 2015 fund was trading recently at a 13% discount to its high-water mark, meaning that investors who buy now receive a guaranteed gain of 13% if they hold their units for the next seven years until maturity. The chances of the fund exceeding that high-water mark are limited by the portfolio’s shift to holding entirely income-generating securities instead of the more balanced mix it started with. Originally, the 2015 fund held 25% in equities.

At the other end of the scale, Destination+ 2025 fund recently traded at a 30% discount to its high-water mark. This fund now has 100% equities exposure, giving clients who buy now the ability to participate in any market gains between now and 2025, as well as receive a guaranteed 30% gain based on the high-water mark already reached.

@page_break@“We don’t rebalance the long-term funds as quickly, as they have more years to gain back any losses,” says Jim Fraser, senior vice president at Mackenzie. “The worst-case scenario for an inves-tor who buys the 2025 fund now is a pretty decent 30% gain.”

Fraser says clients in the shorter-term funds may freely switch to another Destination+ fund with a longer maturity and higher equities component or to any fund within the Mackenzie family.

Target-date funds typically build their portfolios by mixing funds from the same family. The equities exposure of the Destination+ funds is provided by Mackenzie Cundill Value Fund, Mackenzie Maxxum Dividend Fund, Mackenzie Ivy Foreign Equity Fund, Mackenzie Universal Canadian Growth Fund and Mackenzie Cundill Emerging Markets Value Class. The fixed-income component is provided by income and bond funds within the Mackenzie fund family. The maturity guarantee on the Destination+ funds is provided by BMO.

“It’s important for advisors and their clients to address as many risks as possible,” says Fraser, “and these funds come with the silver lining of a high-water mark guarantee.”

He adds that Mackenzie has been seeing positive flows of up to $2 million a day into the Destination+ funds “at a time when many people are paralysed on the sidelines.”

The BMO LifeStage Plus fund family, introduced in June 2007, has seen its assets swell to more than $1 billion in its family of four funds. Their maturities are in 2015, 2020, 2025 and 2030.

Management fees for target-date funds are slightly higher than for regular mutual funds, but decline as the portfolios become more conservative. For example, the MER on BMO LifeStage Plus 2015 Fund has dropped from 2.15% at inception, when the fund held 50% in equities, to 1.05% now that it has shifted entirely to fixed-income. IE