The stock market slump has been a wake up call for investors. Many of those who were near retirement discovered that their portfolio's risk exposure was too high and conservative investing is taking centre stage.
Data collected by Investor Economics and published in November in their most recent Deposits and Fixed Income Report shows that Canadians have shifted more of their assets into deposits, annuities, linked notes, and other fixed income investments. In 2006, about half of all financial wealth was held in the deposit and fixed income category. By last summer, the share had increased to nearly 60%.
"The majority, about $974 billion, is held in retail deposit products such as savings accounts and GICs," notes Andrew Hamer, Senior Analyst, Strategy Consulting, at Investor Economics. "As at June 2009, deposit products alone accounted for 38.6% of all Canadian financial wealth while annuities and linked-notes, fixed income funds, and fixed income securities measured 2.5%, 7.7% and 10.3% respectively."
But are they investing for the long term, or are Canadians taking a wait-and-see approach? The term to maturity data collected by Investor Economics suggests the latter. Mr. Hamer points out that about 84% of all term deposits (this includes GICs, market-linked GICs, and all other fixed-term deposits) have a maturity of three years and under. "Of that amount, $212 billion, or 42% of June 2009 outstanding term deposits, will come due by June 2010," he says.
Shelley Golden is an insurance advisor and GIC broker in Lindsay, Ontario. She says she used radio and print advertising to build her clientele when she started in 1984, and that the business has grown in leaps and bounds since then. She has clients of all ages, but works primarily in the senior market. "I have seen a definite increase in guaranteed product volume since the recent financial crisis," she says, and notes that there has been a significant jump in transfers from mutual funds.
Competition in the interest-bearing space appears to be heating up. While ING was one of the first financial institutions to offer high interest rate savings and investing accounts, newer entrants like Ally Bank and Peoples Trust are competing directly for consumers dollars. At the time of publication another new player, Canadian Direct Financial, a subsidiary of Canadian Western Bank, was offering 2% on savings account balances. In early December, Manulife Financial decided to join in and make a cash grab of its own, launching an incentive program which will pay 2% on all new and existing Tax Free Advantage Accounts between Dec. 15, 2009 to March 15, 2010.
The Insurance and Investment Journal asked Tom Nunn, Assistant Vice President of media relations at Manulife Financial if they had also experienced an uptick in GIC sales. He replied that, yes, the Manulife Bank had seen an increase in GIC business during 2009, but declined to specify the amount.
Segregated funds offer those approaching retirement an opportunity to participate in the equity market while at the same time guaranteeing to return at least 75% of their original capital provided they leave their funds invested for a minimum period of ten years. But what about those who want capital protection but only have a time horizon of seven or eight years?
Larry Stubbs, a Chartered Financial Analyst and head of the financial planning program at the British Columbia Institute of Technology, says that strip bonds are particularly well suited to those who have a retirement horizon of less than ten years. If they invest in Canadian federal and provincial government issues, they can have principal protection and earn a return that is competitive with a GIC, but with a maturity date of their own choosing.
Strip bonds are so named because the interest coupons are stripped away. Instead of collecting regular interest payments, an investor purchases the bond at a reduced face amount and it matures to par value. For example, an investor may have purchased a strip bond in December 2009 for $8041 that will mature in June 2016. This strip would have a semi-annual yield of 3.4%.
"If you are retiring in seven years and have a lump sum to invest, you can buy a strip that will mature on that date," notes Mr. Stubbs. He warns, however, that even though the investor isn't collecting payments, there is imputed interest every year, and the rise in the bond's value is taxable annually. As a result, he recommends only holding strips inside tax deferred accounts like RRSPs, RRIFs or inside tax sheltered TFSAs.
PPNs losing ground?
Principal protected notes (PPNs) were the hot product in 2007 and early 2008, and they typically offered investors stock or hedge fund exposure alongside capital guarantees after a period of five to eight years. However, the market tumble threw most PPN issuers for a loop. The Bank of Nova Scotia, CIBC, the National Bank and Royal Bank all declared "protection events" and shut down dozens of notes in late 2008. Sun Life Financial and Desjardins Group also decided to seal up their PPNs.
Investor Economics says that PPN issuers have reported a significant decline in interest in the market, both among advisors and the population as a whole. The issuers suggest the complex product has become difficult to sell in an environment that favours simplicity and clarity.
Is the PPN's heyday over? Mr. Hamer says that as a general rule, Investor Economics tries to avoid predictions. But he does highlight a few data points from their most recent study, which reveals that 77% of outstanding PPNs will mature within the next five years.
"By the end of 2014, all but 23% of the currently outstanding notes will have matured, suggesting that asset retention has to be a high priority on PPN issuers' and marketers' agendas," reads the report. "The strategies to ‘win over' the maturing dollars will necessarily be shaped by the market and interest rate conditions prevailing at maturity, as well as competitive alternatives."
The document goes on to note that competition in the risk protection continuum has increased recently with the arrival of the guaranteed withdrawal benefit products and open-ended, continuous offering principal-protected mutual funds like BMO LifeStage Plus, IA Clarington TargetClick, and Mackenzie Destination+.
Process not product
Curtis Findlay, an advisor with Worldsource Financial in Canmore, Alberta, chose not to offer PPNs to clients. "I prefer instruments that are understood by the clients and are structured to avoid detailed explanations when they mature regarding why the return, or lack of return, has been calculated by the supplier to be what it is," he says. "Some PPNs have such high fees that the client is very unlikely to realize any gain worth justifying the risk for having variable returns."
In his opinion, advisors can be of most assistance by helping the soon-to-retire get a handle on their situation by tallying their current investments and calculating an approximate future value, then projecting retirement income.
If clients do come up short, Mr. Findlay recommends the advisor outline the specific changes the client needs to make in order to retire when, or how, they had once intended. "Don't be afraid to ask if it's their retirement date or lifestyle expectations that are going to change if insufficient funds are accumulated," he says. "Perhaps adjusting current lifestyle now might be the more palatable decision for some clients."
Mr. Findlay says that any advisor who is unable to prepare this kind of snapshot and act in a consultative style will be at a disadvantage in the retirement market. He expects to see a number of new products introduced as the boomers approach retirement, but suggests that financial innovation is of secondary importance. "I suggest the process is more important than the product selected," he says.
One of the newest principal protected products was introduced by Desjardins Financial last year. Guarantee Advantage is a term deposit whose performance is linked to a basket of equally weighted securities from a specific sector. The issue on offer at the time of writing is linked to ten consumer staple manufactures including Nestle, Kraft, Heinz and Coca-Cola, and matures in January 2016.
Michael Aziz, Regional Vice President of investment product sales at Desjardins Financial Security says that the Guarantee Advantage has both a minimum and maximum return. It is guaranteed to generate an 8% return over the six-year period (an annual return of 1.29%), while total earnings are capped at 35% (5.13% annual return).
"There are surrender options," he says. "It's not like some of the other PPNs where you may have a deferred service charge." The actual surrender value will depend on GIC rates at the time, as well as the distance to maturity. He says the target market is investors who would like the opportunity to earn more than they could in a GIC, but aren't comfortable with the risks of stock market. "I couldn't tell you the percentage, but there is definitely more interest in this type of product. Our seg funds have been doing great, but I think people are still a little bit nervous."
He also points out that with this product, Desjardins actually has the advantage over the banks' market-linked GICs, since Guarantee Advantage carries the features and benefits common to life insurance products, including a 100% death benefit, potential creditor protection and the ability to bypass probate.
Mr. Stubbs points to a recent report from Scotia Mcleod which suggests interest rates in Canada could go up by 100 basis points in the next twelve months. "If the pundits are correct, and rates do go up, both bonds and preferred shares will suffer."
He notes that investors who hold their bonds to maturity do not have to worry about price fluctuations, but warns that those who sell in a rising interest rate environment will get less than they paid. "Remember, these bonds were issued in the past and not at the current rate, which means they are selling at a premium right now. If they sell later, they (clients) could be looking at a capital loss."
Mr. Stubbs is concerned that in the coming RRSP season, investors are going to be buying bonds and bond funds simply because they have posted good results recently. "People tend to shop based on historical returns, and when interest rates inevitably go back up, some of these people are going to get burned," he says. "They have just lost a pile on their equities, and now they may find out that they can lose money in bond funds too. The crowds are always a day late and a dollar short."