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October 10, 2002 at 08:00 PM
Oct. 2, 2002 — During the late 1990s, principal protected funds languished in obscurity as stock prices soared. But in the wake of the prolonged slump in equities, the number and popularity of these funds continue to climb.
As their name suggests, principal protected funds promise nervous investors that they won’t lose a dime of their capital, as long as they commit their capital for a minimum of five years. Indeed, the funds’ creators structure these funds so that holders will even get some upside participation in any stock market rally, as well as full downside protection. In the current market environment, that combination has proved tempting: since last summer, five principal protected funds have raised $2.74 billion in new capital. Another eight funds now in registration should complete the fund-raising process by the end of the year, according to a study prepared by Financial Research Corporation, a Boston-based mutual fund consulting group.
“In the current market environment, the kind of capital preservation guarantee these funds offer has more value to investors than at any time in the last decade,” says Kristin Adamonis of Financial Research Corp., one of the study’s authors.
Until now, occasional efforts to launch this kind of fund in the United States has met only limited success. In contrast, such “guaranteed funds” have been popular in Europe since the mid-1990s as a way for investors to take their first, tentative steps into stock-marketing investing. By the late 1990s, guaranteed funds made up half of all mutual fund sales in countries like Spain and Italy.
The stock-market slump now is helping these funds make inroads in the U.S. as skittish investors try to safeguard their nest eggs. The Smith Barney Capital Preservation fund, offered by investment bank Salomon Smith Barney, raised an astonishing $900 million last spring. Others now being marketed include funds from Merrill Lynch & Co., Frank Russell and BlackRock Partners. A fourth fund from the U.S. funds division of Dutch bank ING just closed on Sept. 30.
“There is so little in the way of equity products that find ready buyers these days, that it’s probably tempting for investment advisors to push them,” says Burt Greenwald, a Philadelphia-based mutual funds consultant. “But they’re not right for all investors.”
While the concept is straightforward, the funds’ structure is not. Managers purchase insurance coverage for the principal amount raised in order to provide the guarantee. To keep the insurance premiums affordable, the fund company must invest a certain portion of the capital raised in risk-free or low-risk investments, such as zero-coupon Treasury bonds. The remainder can be invested in a conservative pool of equities or a stock-market index. That allocation between stocks and bonds is constantly adjusted as interest-rate levels and stock-market volatility rise and fall. For example, the three funds launched by ING since last summer started with 40% of their portfolio in stocks, but now have only about 10% in stocks.
“There’s a risk that investors will be confused about what degree of participation they actually have in the stock market,” says Susan Hirshman, planning strategist for the mutual funds group at JP Morgan Fleming. “Many funds are being marketed as a way to protect your capital and still have upside (stock market) exposure.”
