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By Jonathan Chevreau
National Post
“Advisor Post” Section
Monday, November 07, 2005 |
Life-cycle funds have been heavily promoted to advisors in recent weeks. A variation on several old themes, they need appropriate scrutiny before recommending to clients.
Adrian Mastracci, investment counsel at Vancouver’s
‘fee-only’ KCM Wealth Management, says, “The same asset mix at a particular age is not necessarily applicable to everyone at that age.”
These funds are kinds of time-dated asset allocation funds that get more conservative as predetermined client milestones approach. The further out the maturity date, the more equity exposure; as maturity looms, the asset allocation gradually includes more bond exposure.
The optimal application is a Registered Education Savings Plan. There you know exactly when a child will need the money to pursue higher education. The Royal Bank's RBC Target Education 2010, 2015 and 2020 funds were among the first life-cycle funds in Canada. They are, in effect, global balanced funds that reduce equities and increase bond weightings as the time for university approaches. However, RBC recently closed them to new contributors.
The rest of the industry sees an opportunity to apply life-cycle funds to retirement funds. This use is less obvious than RESPs, since retirement dates are more fluid and extend much further in time.
In the United States, assets in life-cycle funds have grown to US$43-billion from US$10-billion in assets, an increase of 54% per annum. They've had limited penetration in Europe and started to pick up steam in Canada in 2004. That's when fund rules were changed to make it easier for mutual funds to invest in other funds and change their asset mix over time, says Ethical Funds portfolio manager Wusooq Khaleeli.
CIBC and Scotiabank also market life-cycle funds and non-bank manufacturers are now targeting independent broker/dealers. Most recent are the Clarington Target Click funds, which debuted in February, and the new Ethical Advantage Series, announced last week.
Target Click funds come in four versions, maturing in 2010, 2015, 2020 and 2025. The Ethical Advantage series go out further, targeting retirement as far out as 2030 and 2040, in addition to the shorter targets picked by Clarington.
The "Click" refers to a capital gains lock-in feature reminiscent of the Protected Mutual Funds that abounded at the turn of the century and have since faded into the night.
When they hear the wholesaler pitch, some advisors get overly excited about the concept. Advisor Randy Reynolds wrote in the Winnipeg Free Press that Target Click funds will "shake the industry" and "can only be described as brilliant."
However, Adrian Mastracci, president of Vancouver-based KCM Wealth Management, is less enthralled. "The same asset mix at a particular age is not necessarily applicable to everyone at that age." He says clients do not want an autopilot one-size-fits-all approach but a customized one that implements their personal criteria. "Life-cycle funds are better than no strategy, but they are a marketing creation looking for a home."
Undecided advisors could consult a free research report on Click Funds from Windsor, Ont.-based Dan Hallett & Associates Inc. The 14-page report concludes "overall, this is not a product that we would recommend." Chief among his concerns is the difficulty Hallett perceives in using the funds in an overall portfolio context.
Clarington -- no slouch when it comes to marketing -- has an extensive hard-sell kit to promote Click Funds to advisors. In a Toronto presentation I attended, it described Click Funds as mutual funds that protect client investments, GUARANTEED (their emphasis) to automatically lock in month-end highs, automatically reduce risk as the maturity date looms, offer global exposure to conservative investors with daily liquidity, and have competitive MERs that fall as time goes on. The latter is a mere function of the fact the fixed-income exposure rises and equity exposure falls.
One enthusiast for the Clarington version is advisor Kevin Cork, who wrote at FundLibrary.com, "these funds do not guarantee the principal. They guarantee the highest month-end unit price the fund ever reached." To illustrate, Cork says if the 2015 fund unit value over 10 years rose from $10 to $22 in 2008, then fell back to $7 by 2015, investors would be paid $22 per unit at maturity. Of course, like other guaranteed products, you have to hang on to maturity to collect. You can redeem early but only at the current market value.
Simon Segall, vice-president for ABN AMRO Asset Management Canada, described three generations of life-cycle funds. The first was asset allocation funds or wraps. The second was targeted date funds and the third added a guarantee. The second generation was skipped in Canada so Clarington went directly to the third. Citing consumer acceptance in the United States, Segall asserted simply: "Investors want them!"
They will if advisors want them to want them. The appeal for advisors is similar to that of wrap accounts. Life-cycle funds "reduce relationship stress" with clients, Segall said. In bear markets, they keep clients fully invested. In effect, investment decisions are delegated to the life-cycle funds, freeing advisors to help clients on other aspects of their financial lives and/or spend more time building their businesses.
Strip away the hype and you have a complex product that resembles many guaranteed products before them. A hefty amount of the investment is set aside in strip bonds, while the equity exposure comes from a highly leveraged play on ABN AMRO's Global Equity Exposure fund. Put options control downside risk but even then Clarington admits losses of up to 50% in a month are possible.
Hallett expects Target Click to return 4% to 7% a year. The large exposure to bond, cash and futures contracts makes them tax inefficient, so they should be held only in registered plans. In this respect, they resemble bank index-linked GICs, which transmute low-taxed capital gains into high-taxed interest income. But this hefty bond exposure also exposes clients to interest rate risk. A key point Hallett makes is that "holding to maturity is the only way to ensure the guarantee is realized." Even then, Clarington may cause a fund to mature ahead of schedule if it sees fit.
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