By Scott Ronalds

The latest take on principal protected products comes in the form of life cycle funds with capital guarantees.  For those unfamiliar with life cycle funds, they are simply packaged products that have a target end date and shift the asset allocation over time, typically from a heavy equity weighting in the early years to a heavy fixed income weighting in the latter years.  The ‘cycle’ of the funds may be anywhere from 5 to 30+ years.  The thinking is that the investor doesn’t have to do anything throughout the life of the fund because the asset mix changes as they age (and their objectives and risk tolerance changes). 

These products can be useful for investors who want to take a hands-off approach, and for whom a generic asset mix strategy works well.  But as with any packaged product, investors should pay close attention to the fees on these funds, along with any added bells and whistles.

As is all too common in this industry, the manufacturers have taken the life cycle concept a step too far.  Case in point is the Mackenzie Destination+ funds. 

At the beginning of the year, Mackenzie launched three life cycle funds (a fourth was launched in June), with target end dates ranging from to 7 to 17 years.  To make things more enticing – and complicated – they added principal protection and a high-water mark feature to the funds.  Not only are investors guaranteed their principal back if the funds are held until the target end date, they are also guaranteed the highest closing price of the fund throughout its lifetime.  So if the fund rises from $10/unit to $15/unit during the first few years, and then falls to $8/unit towards the target end date, investors will do far better than receiving just their principal back – they’ll get $15/unit.  Sound too good to be true?  It is. 

Less than a year into their existence, Mackenzie has moved all four funds into ‘Protected Portfolio’ status due to significant declines in the global markets and interest rates.  This means they are now comprised entirely of fixed income investments.  Mackenzie and the sub-advisor, Bank of Montreal, determined that the move was necessary to guarantee the funds’ maturity amounts. 

Let’s examine the Mackenzie Destination+ 2025 Fund to see exactly what this means.  According to the prospectus, at the time of its inception last December, the fund’s assets were invested in the ‘Aggressive Model Portfolio’, which consisted entirely of equities.  So in effect, the fund has moved from all equities to all fixed income during the course of its short existence.

The fund reached a high of $10.11/unit back in May (it launched at $10/unit).  Accordingly, investors who hold the fund until its end date in 2025 will receive $10.11/unit.  For those who purchased the fund at or around its inception earlier in the year, this equates to a compound annual return of less than 0.1% over 17 years.  Few, if any, investors could have seen this coming. 

An industry veteran familiar with the product summed it up best in a note to us:

“Its design will always hurt investors and when regulators sus out what is happening I suspect the fall out on this will be worse than PPN’s. The life cycle of the product only works while the market is going up. It doesn't work in markets that go up and down – i.e., it will always have a very short life before it has to go to debt to protect capital – much shorter than its term to maturity...The 2025 hit a bad patch but now investors are stuck for 17 years in a debt fund that does not pay a competitive yield if they want the guarantee amount.”

Given the fund’s dismal prospects, what’s an investor to do?  They have no chance of regaining some of their losses when the market turns around because the fund is invested entirely in fixed income.  One option is to redeem the fund and move on.  It closed yesterday at $6.93, so investors would be locking in a loss of over 30%.  Then there’s the redemption fee of 5.5% for selling in the first year.  Now we’re looking at a 35% haircut.  But surely this beats the second option, which is to hang on to the product and receive virtually no return over 17 years.

The Mackenzie Destination+ funds are yet another example of marketing gone wild.  The funds were designed to generate healthy fees for the sponsor (the reported MER on the 2025 Fund is 3.04%), but when stripped down, there was nothing in it for the investor.  And I’m willing to bet that the professionals who designed this product have none of their own money invested in it.

Surely those individuals with a 17 year investment time horizon would be much better off in a simple, diversified portfolio of stock and bond funds.  A 17 year principal guarantee is ridiculous.  It has a huge cost to it and is playing on investors’ fears in a turbulent time.  We’ve said it before and we’ll say it again – this industry needs to get back into shape.