First guaranteed target date fund matures…early

While the whole guaranteed target date fund industry is still in early adoption stages, the first of the funds have matured nine months early because it’s virtually impossible for the funds’ performance to exceed their current maturity value.

For IA Clarington, the target date fund process has been a success. The firm recently announced an early maturity date for IA Clarington Target Click 2010 Fund of Sept. 18, 2009. IA Clarington was the first to launch guaranteed target date mutual funds in Canada and will pay out on the fund’s guarantee to investors nine months ahead of its original maturity date of June 30, 2010.

It’s an interesting development that underscores that after a certain point in the lifecycle—when the majority of assets have been shifted into fixed income—there is very little value to holding one of these funds to maturity, unless there is an early redemption penalty. In the case of the Target Click Funds, an investor can redeem at their current net asset value, which is essentially the same as the funds highest NAV that will be offered upon maturity.

IA Clarington Target Click Funds are global balanced funds that guarantee at maturity the highest month-end value achieved over their life. As each Target Click Fund approaches its respective maturity date, its allocation to fixed income is increased and its allocation to equities is reduced.

On the road to market recovery, investors might want a longer duration for maturity, but this particular fund no longer has equity exposure. IA Clarington believes investors are better served by cashing in and redeploying their money.

“As the fund is close to it’s maturity date, the fixed income rate has gone up and interest rates remain quite low, especially in shorter term duration,” says Eric Frape, senior vice president of product and business development for IA Clarington. “It’s really limiting the funds’ ability to have further upside as they reach the final year of maturity. We thought it was in the best interest of the fund to accelerate to maturity so investors can take advantage of the guarantee nine months ahead of schedule.”

Frape adds, “Investors have until September 18th to redeem out of the fund. They might want to do it now because the fund’s current NAV is equal to the full guaranteed value, it shouldn’t decrease between now and then anyway.”

If investors don’t redeem before September 18, their assets will be automatically switched over to a money market fund.

IA Clarington’s ability to move up the maturity date on the fund stands in stark contrast to some of its competitors that chose to use a constant proportional portfolio insurance structure (CPPI) in their funds.

When IA Clarington’s target date funds came to market, they used an older and more costly method of securing a guarantee by purchasing a strip bond to cover the guaranteed principal of the fund. This left a smaller pool of the fund’s assets to invest in equities and chase higher growth potential in the early stages of the fund’s lifecycle.

Later entrants into the target date fund space used the CPPI structure. Instead they opted for portfolio models that, if true to historical trends, would have allowed the portfolio to cover off the principal owing based on the long-term performance of a more robust equity weighting.

In a catastrophic market decline, the portfolios would have to sell out of equity positions and allocate as much as 100% of the portfolio to bonds and fixed income to ensure they could pay their maturity guarantees. This is, in fact, what has happened to a number of target date portfolios.

Many of the CPPI-based products are now 100% fixed income products, with time horizons as long as 15 years.

For example, Mackenzie Financial’s former Destination+2020 portfolio and BMO LifeStage Plus 2015 Fund are now 100% fixed income instruments, with no ability to capture any upswing in the equity markets between now and maturity.

“The big difference in these products is the structure we used [especially in comparison] to competitors using CPPI structures,” Frape says. “Typically, most of the structures that use the CPPI have had to wait until the actual maturity date to benefit from the guarantee. Our funds had the bones already. We are able to allow the investors to benefit sooner than planned.”

(07/14/09)