Guarantees may be good but so can the markets
Every so often I'm asked whether there are mutual funds that come with guarantees. My first response is that there are no performance guarantees when it comes to investing. My second response: There are a very few funds that offer return of capital guarantees on their funds. To get those guarantees, however, you've got to follow the rules. And, pay extra.
Whenever the market gets skittish, so do investors. But, wanting to have one foot in the market while keeping the other out, isn't unusual. So , throughout the ages, fund families have come with various ways to get investors into the market by guaranteeing the principal amount that they invest.
In the past, Unit Investment Trusts guaranteed a return of principal, provided that the money stay invested for a specific amount of time. To make the guarantee possible, those portfolios typically held zero-coupon bonds maturing about the same time the guarantee ended.
Today, it's equity funds that are coming to market with guarantees. Pioneer has one in the works, Saloman Smith Barney already has introduced the Smith Barney Capital Preservation Fund, and the ING Funds, a Classic Principal Preservation Fund series---it has been around for a few years. What's behind these guaranteed funds guarantee is insurance.
In all cases, the minimum investors have to do to qualify to get their money-back guarantee, is hold on to their fund shares for a specified amount of time---typically 5-years---and pay an extra annual expense to cover the cost of the insurance. Usually, all income and dividends have to be reinvested back into the fund and no money ever taken out within the money-back guarantee time period.
On the upside, these funds offer comfort to the otherwise nervous investor.
"These aren't a bad thing, if the investor feels they need them, " says Don Cassidy, a senior analyst at Lipper, Inc. " And sometimes the (insurance) are not horrible. I've seen them as low as 25-30 basis points a year on variable annuities. And then, of course, higher."
The Smith Barney Capital Preservation Fund can invest in both stocks and bonds and the guaranteed behind it comes from AMBAC insurance. Investors in this fund have to hold on to their shares for a minimum of five years. The cost for the insurance is 75 basis points per year on top of the fund's other annual expenses.
Julie Russel, a financial consultant at Salomon Smith Barney in Wellington, Fl., says the Capital Preservation Fund a great fit for some of her clients. " I can honestly say to a client that they can buy a premier money manager and no matter what the market does five years from now, you'll get your money back."
INGs Principal Preservation funds also requires a 5-year investment commitment, shareholders must reinvest all dividend and interest income back in to the fund and not take any money out of if the insurance backing is to be honored.
On the downside, five years is considered a long-term investment in the minds of many money pros and insurance isn't the only way to cover your assets. "Another way to give yourself more of a potential upside is to buy a decent balanced fund, " suggest Cassidy. "Yeah, the fund could be down at some point in time, but you'll have unlimited upside potential if you hold it (the fund) long term."
And then there are the markets. Look at past performance over 5- and 10-year rolling periods of the S & P 500, and you've got to wonder if guaranteed funds are worth the extra cost: According to Ibbotson Associates, the Chicago-based securities research firm, over the past 76 years, (from 1926 through 2001), there was a 10 percent chance of market loss over 5-year rolling periods; and over 10-year rolling periods, the chance of loss was 3 percent.
Dian Vujovich is a nationally syndicated mutual fund columnist, author of a number of books including Straight Talk About Mutual Funds (McGraw-Hill), and publisher of this web site.
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