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By Paul Delean
Montreal Gazette
Monday, February 13, 2006
Equity-indexed products are tricky. Ability to redeem whenever you want without high penalty can be valuable.
Adrian Mastracci, investment counsel at Vancouver’s ‘fee-only’ KCM Wealth Management, says, "If something starts to go haywire, I would want to be able to sell.”
Despite turbulence last week, for now, Canadian stock markets remain in the throes of a prolonged surge.
So what would you guess the annual return was through Feb. 1 on a Quebec savings bond tied to the performance of 30 large Canadian stocks since March 2002? Would you believe 1.41 per cent? That's been the meagre reward, on paper, for buyers of the provincial government's index-linked bonds dating from March 2002.
If the index goes down over the next 13 months, the return on the five-year bonds could conceivably be zero when they come to term in 2007 (though the principal is guaranteed).
Yet those who bought the same product just seven months later, in September 2002, are looking at an attractive annual return of 8.28 per cent so far.
That's how quickly things can change in financial markets, and one of the reasons many financial planners are lukewarm to the guaranteed and index-linked products being heavily promoted this RRSP season.
While it's true the capital is safe and the potential reward greater than for standard GICs, there's a downside in that investors have limited control over the asset before maturity, leaving them at the mercy of market swings. If you hit a downslide just as your investment is coming to term, tough luck.
"If something starts to go haywire, I would want to be able to sell," noted adviser Adrian Mastracci, who is not a fan of principal-protected notes and index-linked GICs.
Some of the index-linked products come with a clause allowing the issuer to redeem them at mid-term for a return that could be significantly lower than the index it's tracking. Some have a capped maximum return, or fairly steep fees.
If they are cashed before maturity on a secondary market, there may be redemption penalties, and the surrender value could be quite a bit lower than the paper value. If the investment is held for the duration, the returns are taxed as interest rather than capital gains, a significant disadvantage if held outside an RRSP.
Not all advisers dismiss index-linked or principal-protected products. Some consider them suitable for a portion of investors portfolios, particularly within RRSPs. But on the whole, advisers contacted by The Gazette were decidedly cool to the category.
So what are they recommending to clients seeking income inside and outside RRSPs? Here's what they told us:
Adrian Mastracci, KCM Wealth Management: "I’m not a great believer in fancy things like stock-indexed GICs and protected notes. Savings bonds are not on the list either for their low rates. Many income mutual funds have high (management expense ratios), so I skip them.
"Most GICs have low yields, so I typically ignore them.
"My approach is to keep the fixed-income portion of the portfolio simple, while minding the costs. I prefer maturities of up to five years in this environment, in a ladder format, with a couple of maturities per year.
"For the short end, you could have treasury bills, and for up to five years, federal and provincial strip coupons. There are ETFs (exchange-traded funds) as well for investors who want a basket approach. For those who can stand the risk, a basket of dividend securities and income trusts would be my choice."
Keith Donoghue, Berkshire Securities: "It is always dependent on the client's needs and risk tolerances. If clients are looking for capital guarantees but with an income stream, some of the protected notes from the fund companies/banks are very interesting.
"I am not in favour of the low- interest-bearing GICs or savings bonds.
"If a client can accept more risk and the money is non-registered, then a combination of income trusts and dividend-paying stocks would yield more on an after-tax basis.
"One fund I like very much is the TD Monthly Income fund, which is about 40-per-cent dividend-paying stocks, 30-per-cent income trusts and 30-per-cent bonds."
Continued on Page 2
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