Market volatility, soaring oil prices and economic uncertainty are creating high levels of anxiety among many clients, and some are probably having doubts about their exposure to equities. One answer for these clients may lie in a niche category of mutual funds that combines peace of mind with some exposure to stocks in a balanced portfolio.

These fund products combine “target date” investing with a lock-in and guarantee of gains made along the way. They can help clients stay invested in bear markets, and avoid the relationship stress that often arises between advisors and their clients when non-guaranteed assets drop in value.

Although several fund companies offer life-cycle or target-date fund portfolios that invest more conservatively as the funds head toward their maturity dates, only a handful are offering high-water mark guarantees. These fund companies include Toronto-based IA Clarington Investments Inc., the first retail fund company to enter the market about three years ago, as well as more recent entrants Bank of Montreal and Mackenzie Financial Corp., both Toronto-based.

These funds come with various maturity dates, and clients can choose dates that coincide with events such as retirement or a child’s university education. Maturity dates can also be staggered by spreading investments across different target dates so that the guaranteed money will become available at a variety of times.

Management fees for these funds are slightly higher than those of regular balanced funds.

“For people who are nervous, the funds with a lock-in feature offer a low-risk way to attain some equity exposure,” says Rudy Luukko, in-vest-ment funds editor with Morningstar Canada in Toronto.

Essentially, the target-date funds protect clients from market fluctuations while providing the long-term growth opportunities and asset allocation of a global balanced fund portfolio. Typically, 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 downside is that an asset mix determined by time horizon — and thus the allocation decisions made by the fund manager — may not suit every individual’s objectives.

“In practice, a client’s appropriate asset mix should be determined by individual return targets, ability and willingness to assume risk, time horizon, liquidity needs, tax issues, legal issues and other considerations, “ says fund analyst Dan Hallett, president of Windsor, Ont.-based Dan Hallett & Associates Inc. “These funds also ignore tax-friendly portfolio-management basics, such as putting interest-generating funds inside registered plans while keeping equities outside such plans when a client has both registered and non-registered assets.”

The latest company in this niche is Mackenzie, which introduced Mackenzie Destination+ funds in January. The new fund-of-fund portfolios have high exposure to equities at the outset, but gradually increase their exposure to income securities as the maturity date approaches. The investment focus shifts over time from growth to balanced, then to conservative and, finally, to protected. There are currently three maturity dates — 2015, 2020 and 2025. If clients change their minds or their goals, and are willing to forgo the guarantee, they can redeem the funds any business day at net asset value.

The Mackenzie funds have a daily lock-in feature, which means that every time a fund achieves a new daily high in NAV, a new level is determined for the guarantee. This means investors who hold to maturity capture the growth even if the fund later suffers a drastic drop. The guarantee on Mackenzie’s funds is provided by Bank of Montreal.

Clients can buy the Mackenzie funds after the high-water mark has been achieved and still receive a guarantee on the highest value achieved by the fund, even if the clients were not holding the fund when that high was reached; they’re simply required to hold to maturity.

“Individuals who are sitting in cash are frightened of two things,” says David Feather, president of Toronto-based Mackenzie Financial Services Inc. “They’re afraid of putting money in the market and watching it go down, and they’re afraid of not putting money in the market and watching it go up. The daily lock-in feature on the Destination+ funds allows investors continually to reset the high-water mark without extending the guarantee period.”

The fees for target-date funds are straightforward and transparent. For example, the front-end version of a Mackenzie Destination+ fund starts with a total management expense ratio of 3.08%, which declines as the portfolio becomes more conservative, ending up at slightly higher than 1% when the portfolio becomes pure fixed-income. By comparison, the front-end version of Mackenzie Ivy Global Balanced Fund has an MER of 2.39%. The difference means clients are initially paying a premium of about 70 basis points for the target-date guarantee, although this premium declines as the fixed-income component increases in the portfolio.

@page_break@ Other funds in this product category include Target Click funds, sponsored by IA Clarington, and BMO’s LifeStage Plus family of funds. But, unlike Mackenzie and BMO, which offer a daily lock-in feature, IA Clarington’s family has a monthly lock-in based on monthend NAVs.

IA Clarington was the first retail fund company in Canada to offer a target date combined with high-water mark guarantees. This fund family has struck a chord with nervous investors and the funds’ popularity has increased during the past several months as bearish sentiment has intensified, says Eric Frape, senior vice president of product and business development. Assets in the family currently stand at $321 million and, he says, sales in the 2008 RRSP season were double those of a year earlier.

“There is a shift to risk-averse products with an aging demographic looking for more security, and that’s a long-term driver for the product,” says Frape. “On a shorter-term basis, stock market volatility and growing uncertainty are also driving demand.”

IA Clarington Target Click 2010 Fund shows an average annual compound return of 4.2% for the three years ended April 30, while the 2025 version, which has a higher percentage of equities, shows an average annual return of 8.2%.

Frape says IA Clarington is likely to extend its lineup with a 2030 version later this year. The guarantee is provided by Fortis Bank SA de NV, one of Europe’s top 20 financial services institutions. As with any guaranteed product, the reputation and stability of the guarantor is a key consideration.

Target-date portfolios are typically a mix of funds from the same family. For example, the equity 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 Mackenzie Sentinal Income Fund, Mackenzie Sentinal Bond Fund and Mackenzie Sentinel Corporate Bond Fund. By the end of the target-date funds’ lives, they will have shifted completely to fixed-income.

“Purchasers should carefully examine [fund] components and assess the track records of the underlying managers,” says Luukko.

It’s possible that if the funds run into a bearish period that reduces the value of stock holdings, the manager might need to switch assets out of equities and into fixed-income to assure that guarantees will be met. If this reduced equity exposure happens early in the fund’s life cycle, it could mean less exposure to growth than a balanced portfolio would typically provide, making the fund more like a bond product.

However, clients are free to switch out of the funds at any time, as long as they are prepared to forgo the guarantee, notes Jim Fraser, senior vice president at Mackenzie.

They could switch with no penalty into another Destination+ fund with a longer maturity and higher equity component, he says, or into a regular mutual fund within the Mackenzie family. IE